UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

Form 10-K

|ý                                                             | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:    
|------------------------------------------------------------- | -----------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2007                  
|o                                                             | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:
|For the transition period
from                             to

Commission file number 001-32966

Osiris Therapeutics, Inc.(Exact name of registrant as specified in its charter)

|Delaware(State or other jurisdiction of incorporation or organization)                 |  | 71-0881115(I.R.S. Employer Identification No.)
|-------------------------------------------------------------------------------------- |  | ----------------------------------------------
|7015 Albert Einstein Drive, Columbia, Maryland(Address of principal executive offices) |  | 21046-1707(Zip Code)                          
|443-545-1800(Registrant's telephone number, including area code)                      
|Securities registered pursuant to Section 12(b) of the Act:                           

Title of Each Class

Name of Each Exchange on with RegisteredCommon Stock, $0.001 par value

NASDAQ Global Market


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o    No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o    No ý

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 ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405of
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. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

|Large accelerated filer o |  | Accelerated filer ý |  | Non-accelerated filer o (Do not check if a smaller reporting company) |  | Smaller reporting company o
|------------------------- |  | ------------------- |  | --------------------------------------------------------------------- |  | ---------------------------

Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes o    No ý

On June 30, 2007, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of voting Common
Stock held by non-affiliates of registrant, based upon the last sale price of the Common Stock reported on the NASDAQ Global Market was approximately $201,789,000.

The
number of shares of the registrant's Common Stock outstanding as of March 9, 2008 is 31,652,561.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive Proxy Statement for our 2008 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within
120 days after the end of our 2007 fiscal year are incorporated by reference into Part III of this Annual Report on Form 10-K.



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OSIRIS THERAPEUTICS, INC.  Annual Report on Form 10-K  Fiscal Year Ended December 31, 2007

INDEX

|         |          |  |                                                                                                                  | Page
|-------- | -------- |  | ---------------------------------------------------------------------------------------------------------------- | ----
|PART I   |          |  |                                                                                                                  |     
|         | Item 1.  |  | Business                                                                                                         |     
|         | Item 1A. |  | Risk Factors                                                                                                     |     
|         | Item 1B. |  | Unresolved Staff Comments                                                                                        |     
|         | Item 2.  |  | Properties                                                                                                       |     
|         | Item 3.  |  | Legal Proceedings                                                                                                |     
|         | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                              |     
|PART II  |          |  |                                                                                                                  |     
|         | Item 5.  |  | Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |     
|         | Item 6.  |  | Selected Financial Data                                                                                          |     
|         | Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                            |     
|         | Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                       |     
|         | Item 8.  |  | Financial Statements and Supplementary Data                                                                      |     
|         | Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosures                            |     
|         | Item 9A. |  | Controls and Procedures                                                                                          |     
|         | Item 9B. |  | Other Information                                                                                                |     
|PART III |          |  |                                                                                                                  |     
|         | Item 10. |  | Directors, Executive Officers and Corporate Governance                                                           |     
|         | Item 11. |  | Executive Compensation                                                                                           |     
|         | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                   |     
|         | Item 13. |  | Certain Relationships and Related Transactions, and Director Independence                                        |     
|         | Item 14. |  | Principal Accounting Fees and Services                                                                           |     
|PART IV  |          |  |                                                                                                                  |     
|         | Item 15. |  | Exhibits, Financial Statement Schedules                                                                          |     

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PART I

Item 1.    Business.

Forward-Looking Information

This Annual Report on Form 10-K includes "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act
of 1934, or the Exchange Act. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures,
compensation arrangements, financing needs, plans or intentions relating to collaborations or business combinations, business trends and other information that is not historical information and, in
particular, may appear under the headings "Risk Factors" in this Part IItem 1A, "Part IIItem 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the other documents we file with the Securities and Exchange Commission, or SEC, including, among others, our quarterly reports on Form 10-Q
and any amendments thereto.

When
used in this Annual Report, the wordsestimates, expects, anticipates, projects, plans, intends, believes, forecastsand variations
of such words or similar expressions are intended to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements regarding the following:
our product development efforts; our clinical trials and anticipated regulatory requirements; the success of our product candidates in development; status of the regulatory process for our biologic
drug candidates; implementation of our corporate strategy; our financial performance; our product research and development activities and projected expenditures, including our anticipated timeline and
clinical strategy for Mesenchymal Stem Cells (MSCs) and biologic drug candidates; our
cash needs; patents, trademarks and other proprietary rights; ability of our potential products to treat disease; our ability to supply a sufficient amount of our products to meet regular and repeated
demand; our costs to comply with governmental regulations; our relationship with collaborating partners; our ability to benefit from government contracts; our plans for sales and marketing; our plans
regarding facilities; types of regulatory frameworks we expect will be applicable to our potential products; and results of our scientific research.

All
forward-looking statements, including, without limitation, management's examination of historical operating trends, are based upon our current expectations and various assumptions.
Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management's expectations, beliefs
and projections will result or be achieved.

There
are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this Annual Report. Important
factors that could cause our actual results to differ materially from the forward-looking statements we make in this Annual Report are set forth in this report, including "Risk Factors." There may be
other factors that may cause our actual results to differ materially from the forward-looking statements.

All
forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Annual Report and are expressly qualified in their entirety by the
cautionary statements included herein. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances and do not intend to do so.

When
we use the terms "Osiris," "we," "us," and "our" we mean Osiris Therapeutics, Inc., a Delaware corporation.

Company Overview

We are a leading stem cell therapeutic company headquartered in Columbia, Maryland and focused on developing and marketing products to treat medical conditions in
the inflammatory,

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orthopedic,
and cardiovascular areas. We were incorporated in Delaware in April 2002. Our predecessor company was organized in 1992. We currently manufacture, market and sell Osteocel® for
regenerating bone in orthopedic indications. It is the only commercially available product in the U.S. containing viable stem cells. Our lead biologic drug candidate, Prochymal, is being
evaluated in Phase III clinical trials for three indications, including acute and steroid refractory Graft versus Host Disease ("GvHD") and Crohn's disease, and is the only stem cell
therapeutic currently granted both Orphan Drug and Fast Track status by the Food and Drug Administration ("FDA"). Prochymal is also being developed for the repair of heart tissue following a heart
attack and for protection of pancreatic islet cells in patients with type 1 diabetes. Our pipeline of internally developed biologic drug candidates under evaluation also includes Chondrogen for
osteoarthritis in the knee. We have also partnered with Genzyme Corporation to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies.

Osiris
is a fully integrated company, having developed capabilities in research, development, manufacturing, marketing and distribution of stem cell products. We have developed an
extensive intellectual property portfolio to protect our technology in the United States and a number of foreign countries including 47 U.S. and 253 foreign patents owned or licensed.

Osteocel
and our two biologic drug candidates utilize human mesenchymal stem cells, or MSCs. MSCs can selectively differentiate, based on the tissue environment, into various tissue
lineages, such as muscle, bone, cartilage, marrow stroma, tendon or fat. In addition, MSCs have anti-inflammatory properties and can prevent fibrosis or scarring. These characteristics
give MSCs the potential to treat a wide variety of medical conditions. We believe that our biologic drug candidates have advantages over other stem cell therapeutics in development for the following
reasons:



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The
following table summarizes key information about Osteocel and our biologic drug candidates.

|Product/Candidate |  | Indication                            |  | Status     
|----------------- |  | ------------------------------------- |  | -----------
|Osteocel          |  | Spinal Procedures                     |  | Marketing  
|                  |  | Orthopedics                           |  | Marketing  
|Prochymal         |  | Steroid Refractory Acute GvHD         |  | Phase III  
|                  |  | First Line Treatment of Acute GvHD    |  | Phase III  
|                  |  | Biologics Refractory Crohn's Disease  |  | Phase III  
|                  |  | Type I Diabetes                       |  | Phase II   
|                  |  | Acute Myocardial Infarction           |  | Phase II   
|                  |  | Acute Radiation Syndrome              |  | Preclinical
|Chondrogen        |  | Osteoarthritis & Cartilage Protection |  | Phase I/II 

Osteocelconsists of a matrix of cancellous bone containing mesenchymal stem cells and is used in spinal fusion and other orthopedic
surgical procedures. Cancellous bone is the porous and spongy inner structure accounting for approximately 20% of total bone mass. Osteocel is the only commercially available product containing viable
stem cells in the United States. We launched Osteocel in July 2005 and to date it has been used in over 15,000 surgical procedures. We produce Osteocel from the marrow-rich bone of organ
and tissue donors, and we believe that it is properly characterized, and regulated by the FDA, as a human cell, tissue, and cellular and tissue-based product, or HCT/P, under section 361 of the
Public Health Service Act. Unlike our biologic drug candidates, our ability to supply Osteocel is limited by the amount of marrow-rich bone that we are able to obtain from organ and tissue
donors. Osteocel is currently distributed non-exclusively by us and by Blackstone Medical (a subsidiary of Orthofix International NV) for orthopedic indications, and jointly by us
and Blackstone Medical for spinal procedures. We are party to a multi-year agreement with AlloSource, a non-profit tissue procurement organization for the supply by AlloSource
to us of tissue for use in the manufacture of Osteocel. Under the terms of the agreement, AlloSource has committed to provide bone matrix to us for use in the production of Osteocel, and to ensure
that the technology is made available to the communities from which it is sourced, the agreement also enables AlloSource to act as a non-exclusive distributor of Osteocel in AlloSource's
local donor communities. Recently, we entered into a multi-year agreement with Tissue Banks International (TBI), a non-profit tissue procurement organization for the supply by
TBI to us of tissue for use in the manufacture of Osteocel. Under the terms of the agreement, TBI has committed to provide bone matrix to us for use in the production of Osteocel, and to ensure that
the technology is made available to the communities from which it is sourced, the agreement enables TBI also to act as a non-exclusive distributor of Osteocel in TBI's local donor
communities.

Prochymalis our lead biologic drug candidate and is being evaluated in Phase III clinical trials for three indications, including
the first line treatment of acute GvHD, steroid refractory acute GvHD and
biologics refractory Crohn's disease and is the only stem cell therapeutic currently designated by the FDA as both an Orphan Drug and Fast Track product.



We are currently enrolling patients in a pivotal Phase III trial for the treatment of steroid refractory acute GvHD. GvHD is a life threatening immune
system reaction that commonly affects the skin, gastrointestinal tract, and liver in patients who have received a bone marrow transplant. Although in the U.S. there are no drugs approved for treating
GvHD, the disease is commonly treated off-label with steroids. GvHD that does not respond to this treatment is known as steroid refractory GvHD. A large majority of steroid refractory GvHD
patients die within six months. In our Phase II trial for treatment refractory GvHD, we enrolled patients that did not respond to treatment with steroids and at least one second line therapy.
Of these patients, 59% responded to Prochymal.

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Our
Phase III trial to evaluate Prochymal as a treatment for steroid refractory GvHD is a randomized, double blind, placebo controlled study designed to enroll up to 240 patients.
The trial is investigating patient response to eight infusions of Prochymal administered twice per week for four consecutive weeks. The primary trial endpoint is complete resolution of GvHD for at
least 28 day duration. Each patient will also be monitored for safety for up to 180 days after their first treatment with Prochymal. Six-month survival is a key secondary
endpoint. This trial is being conducted in approximately 80 centers in the United States, Canada, Europe and Australia.



We are also enrolling patients in a Phase III trial evaluating Prochymal as an add-on therapy to steroids for the first-line
treatment of acute GvHD. Our Phase II trial for treatment of newly diagnosed acute GvHD, found that patients were twice as likely to have total clinical resolution of their disease when
Prochymal was added to steroid therapy, compared to reported results for steroid only treatment. Twenty-nine of 31 patients, or 94% responded after receiving two infusions of Prochymal,
with 24 patients, or 77% achieving a complete response, meaning the patients had experienced total clinical resolution of the disease. At six months, 61% of all patients treated with Prochymal still
had a durable response requiring no additional immunosuppressive therapy,
clinical intervention, or increased steroid use. Furthermore, 95% of patients achieving a durable response were alive at six months.

Our
Phase III trial to evaluate Prochymal as a first line treatment for GvHD is a randomized, double blind, placebo controlled study designed to enroll up to 184 patients. The
trial is investigating patient response to a total of six infusions during the first four weeks of the study. The primary trial endpoint is the proportion of patients who achieve a complete response
at day 28 and who survive to day 90 without the addition of a second line therapy. The study is being conducted at approximately 50 centers in the United States and Canada.



Based on our clinical observations of the effects of Prochymal on the gastrointestinal symptoms of patients with GvHD, we are developing Prochymal for the
treatment of Crohn's disease. Crohn's disease is a chronic condition that results in inflammation of the gastrointestinal tract. We have completed patient enrollment in a Phase II trial for
Crohn's disease under a separate Investigational New Drug application ("IND"). We received Fast Track designation from the FDA, for the development of Prochymal for moderate to severe Crohn's disease
patients that are refractory to standard therapies, including biologics.

We
are currently enrolling patients in a Phase III trial evaluating Prochymal for the treatment of moderate to severe Crohn's disease that is refractory to biological therapy. The
study is designed to enroll up to 258 patients and is double blind, placebo controlled, and includes patients, 18 to 70 years of age, with a Crohn's Disease Activity Index ("CDAI") greater than
250. The primary endpoint of this trial is the proportion of patients with CDAI of less than 150 (clinical remission) at day 28. The study is being conducted at 50 leading centers in the United States
and Canada.



Prochymalis also being evaluated for the repair of heart muscle in patients who have suffered a heart attack.
Based on statistics published in 2005 by the American Stroke Association and the American Heart Association, approximately 700,000 individuals in the United States each year experience their first
heart attack. According to these same statistics, approximately 20% of these patients suffer extensive damage to their heart muscle leading to heart failure within six years. In preclinical studies in
animal models, Prochymal targeted the damaged area of the heart following a single intravenous infusion. These studies also indicate that Prochymal prevents scar formation that

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typically
occurs after a heart attack and improves cardiac function eight to ten weeks after its administration.

We
completed enrollment in a Phase I clinical trial for Prochymal to evaluate its safety and efficacy to restore heart function in patients experiencing a first time myocardial
infarction (MI). In March 2007, we reported six-month results in this trial. In a 53-patient, double-blind, placebo-controlled study evaluating the safety and preliminary
efficacy of the intravenous administration of Prochymal, MI patients receiving the therapy had significantly lower rates of adverse events, such as cardiac arrhythmias, as well as significant
improvements in heart, lung and global function. Administration of Prochymal was found to be well tolerated at all dose levels. Based on these positive findings, we have received approval from the FDA
to initiate a Phase II trial.



We have recently initiated a Phase II, 60 patient, placebo controlled study in the United States for the treatment of early onset type 1 diabetes in
individuals 18 to 30 years old. We believe that based upon their mechanism of action, MSCs may home to the pancreas and inhibit the local immune and inflammatory responses, preventing the
destruction of pancreatic islets and promoting the repair of pancreatic tissue damage. Patients must be enrolled within 2 to 16 weeks of being diagnosed with type-1 diabetes and
will receive three infusions of Prochymal over the course of 60 days. Primary efficacy will be measured at six months and the primary endpoint is the marker of insulin response in response to
glucose stimulation. We have entered into a collaborative agreement with the Juvenile Diabetes Research Foundation ("JDRF") for this study. This agreement provides for JDRF to fund $4.0 million
of clinical study costs during 2008 and 2009.



In 2007, we partnered with Genzyme Corporation to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In
January 2008, we were awarded a contract from the United States Department of Defense ("DoD") for the development and stockpiling of Prochymal for the treatment of acute radiation syndrome ("ARS").
Under the terms of the contract, DoD will provide funding to us in two stages, with an initial amount of $4.2 million expected to be earned in 2008. The fully funded value of the contract,
assuming FDA approval of Prochymal for ARS and exercise by DoD of all of its purchase options for up to 20,000 doses of Prochmal at current prices ($10,000 per dose) is up to $224.7 million. We
will carry out this contract in collaboration with Genzyme.

Chondrogenis our biologic drug candidate for the treatment of osteoarthritis and the reduction of pain in the knee. According to a 2005
article in theAmerican Journal of Sports Medicine, approximately 1.0 million people have surgery to remove damaged or torn meniscus in the
United States each year. As noted in a 1999 article in the journalSports Medicine, patients who have had this procedure are 10 to 15 times more likely
to develop osteoarthritis, a highly debilitating orthopedic condition. There are currently no FDA approved products available to regenerate meniscal tissue. In several preclinical studies, Chondrogen
regenerated meniscal tissue and prevented osteoarthritis in animal models. We recently completed enrollment in a Phase I/II clinical trial for Chondrogen to evaluate its safety and efficacy in
patients following surgery to remove torn meniscus. A total of 55 patients were treated in the Phase I/II, double-blind study evaluating the safety and exploratory effectiveness of Chondrogen,
a preparation of adult stem cells formulated for direct injection into the knee. At the twelve month time point, Chondrogen met its primary endpoint, demonstrating product safety. The data also showed
improvements in joint condition that correlated with a clinically and statistically significant improvement in pain in patients with osteoarthritis (OA) who received Chondrogen as compared to those
treated with the control, hyaluronic acid (HA). Patients will be followed for safety and additional

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preliminary
efficacy, such as cartilage damage and changes in the meniscus for two years under the current study protocol.

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We
expended approximately $50.9 million in fiscal 2007, $37.6 million in fiscal 2006, and $16.9 million in fiscal 2005, on research and development. Our research and
development expenditures in 2007 and 2006 were entirely sponsored by us. In 2005, we were reimbursed for $1.4 million of research and development expenditures through grants with the U.S.
government. For more detailed financial information, including information regarding our revenues, profit and loss, and total assets and research
and development costs and expenses for the past three fiscal years, see our Financial Statements included in Item 8 to this Annual Report on Form 10-K for fiscal year 2007.

Scientific Background

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

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

In
the adult, two major classes of stem cells exist in bone marrow, hematopoietic stem cells and mesenchymal stem cells. Throughout life, hematopoietic stem cells, or HSCs, located
within the bone marrow give rise to most types of blood cells. HSC transplantation has served as the basis for a number of aggressive treatments for various types of cancer. However, therapies based
on HSCs are largely limited to hematological disorders because HSCs can only differentiate into blood cells.

In
contrast to HSCs, mesenchymal stem cells, or MSCs, are progenitor cells that differentiate into various connective tissues, such as bone, muscle, fat, tendon, ligament, cartilage and
bone marrow stroma when they receive appropriate biochemical and biomechanical signals. Other biochemical stimuli cause MSCs to mobilize to areas of injury or inflammatory disease. Once there, MSCs
coordinate tissue regeneration at a local level by producing tissue growth factors and by interacting with local cells to reduce inflammation and scarring. Importantly, MSCs do not express markers on
the surface of cells, known as HLA class II antigens, which are responsible for recognition of the cells by the immune system. Also, the cell surface markers, CD40, CD80 and CD86, which are
essential for activation of immune cells, are not present on MSCs. These characteristics allow MSCs to:



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MSCs and HSCs are most readily isolated from bone marrow. Because MSCs represent a small fraction of bone marrow cells, they require amplification to be clinically useful. We have
developed and optimized a proprietary process for isolating and expanding these cells using standardized cell culture methodologies. We can grow MSCs in a controlled fashion to produce up to 10,000
treatments of our biologic drug candidates from a single bone marrow donation.

Stem
cells can be derived from either the patient, referred to as an autologous source, or from a donor, referred to as an allogeneic source. For many cell therapies, allogeneic sourcing
is not possible due to the immune response that typically occurs following the injection of unrelated cells. The non-immunogenic nature of MSCs permits allogeneic cell sourcing and carries
significant advantages over autologous sourcing. Allogeneic cell sourcing from a healthy donor population allows for specific quality control measures to select therapeutically optimal stem cells. For
example, if a patient's cells are of poor quality due to advanced age, disease or metabolic state, the product to be re-infused will likely be of similar poor quality. We believe that
allogeneic sources used in large scale production will enable us to utilize quality control practices to ensure that product potency is reproducible from treatment to treatment. We have developed and
continue to develop quality standards for our biologic drug candidates, including potency assays directed to the specific indications for use. To our knowledge, no patients participating in our
clinical trials or who have used Osteocel to date have experienced an immunogenic response.

Strategy

We are striving to be the first company to receive FDA marketing approval and to commercialize a stem cell drug therapy and become the world's leading provider of
stem cell therapies.

Successfully commercialize our lead stem cell therapy, Prochymal.We are currently enrolling patients in three
Phase III clinical trials for Prochymal. Assuming marketing approval, we plan to develop a sales and marketing force to promote Prochymal initially for the first line treatment of acute GvHD
and steroid refractory acute GvHD, followed by moderate to severe Crohn's disease. Based on the small number of bone marrow transplantation hospitals in the United States and the lack of effective
treatments for this population, we believe we can successfully market Prochymal with a specialized sales force for the treatment of GvHD.

Expand our pipeline of biologic drug candidates where our stem cell technology has a therapeutic potential.We are
continuously investing in our biologic drug candidate pipeline by evaluating our therapies in additional diseases and disorders where we believe MSCs have potential therapeutic benefit. This will
allow us to maintain our position as the leader in cellular therapeutics.

Exploit our MSC technology, manufacturing ability and proprietary know-how to advance our pipeline.We intend to
leverage our preclinical research, safety data and manufacturing ability to rapidly and efficiently grow our biologic drug candidate pipeline. Because we utilize MSCs as the active agent for all of
our biologic drug candidates, we believe the accumulated safety data will reduce the time and cost associated with early stage clinical trials for new indications.

Internally develop and commercialize future biologic drug candidates.We believe that we have the requisite experience to
develop and commercialize our unpartnered biologic drug candidates and any future biologic drug candidates without the help of a strategic partner. Due to our experience with Osteocel and our current
pipeline candidates, we believe we have gained the clinical, regulatory, manufacturing and commercial capabilities to successfully develop and commercialize biologic drug candidates.

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Marketed Product

Osteocel®

Osteocel consists of a matrix of cancellous bone containing mesenchymal stem cells and is used in spinal fusion and other orthopedic surgical procedures. It is
the only commercially available product in the United States containing viable stem cells. We launched Osteocel in July 2005 and to date it has been used in over 15,000 surgical procedures. Osteocel
is currently distributed non-exclusively by us, Blackstone Medical, AlloSource and TBI for orthopedic indications, and by us jointly with Blackstone Medical for spinal procedures.

According
to data published by the Centers for Medicare and Medicaid Services, over 900,000 surgeries are performed in the United States each year that require the reconstruction or
replacement of bone. The standard of care is a procedure known as autograft, in which bone is harvested from another site
within the same patient and transferred to the site of injury. The harvested bone contains stem cells and is often an effective agent for regenerating bone. However, this procedure has significant
disadvantages. An additional surgery is required to obtain the autograft bone, resulting in increased time under anesthesia, additional blood loss, and the costs associated with an additional surgery.
These patients also face an increased risk of infection and may experience chronic post-operative pain from the harvest procedure. As noted in an article published by the University of
California, Los Angeles (UCLA) Department of Orthopaedic Surgery, complications from the autograft harvest occur in up to 35% of patients having the procedure. As such, we believe there is a
significant medical need for a product that can promote bone formation reliably and eliminate the need for autograft.

Spinal
fusion is a surgical procedure used to correct problems in the spine bones, or vertebrae, and is one of the most common and expensive surgeries in orthopedics. Based on data
published by the Centers for Medicare and Medicaid Services, there were 450,000 spine fusion surgeries in 2003, associated with multi-billion dollar health care costs. All spinal fusion surgeries
require autograft or other material to support bone formation. Non-viable bone sourced from cadavers, synthetic materials, and recombinant growth factors are used as alternatives to
autograft. Each has significant limitations and none has the same regenerative characteristics of autograft. While Osteocel contains the same bone forming properties as autograft, it has several
distinct advantages:



Osteocel
works in three ways. The cancellous bone matrix of Osteocel is osteoconductive, meaning it encourages new bone growth by providing a scaffold to support bone formation. Osteocel
is also inductive. Osteoinduction is the indirect promotion of bone formation by recruiting the patient's cells to the site through signaling mechanisms. Lastly, the stem cells contained in Osteocel
make it
osteogenic. Osteogenesis is the ability of certain cells to form bone directly. Only two current treatments contain all three of these necessary components for new bone growth: autograft and Osteocel.
Over the past 10 years our scientists have published over 20 peer reviewed journal articles demonstrating the consistent osteogenic capabilities of the MSCs in Osteocel.

We
produce Osteocel from the marrow-rich bone of organ and tissue donors. Since its introduction in July 2005, we have been unable to produce quantities of Osteocel
sufficient to meet surgeon demand. During 2006, we were constrained by our manufacturing facility and limitations on the supply of marrow-rich bone obtainable from adult organ and tissue
donors. To increase our ability to supply

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our
customers, we expanded our manufacturing capacity and increased the number of organ and tissue agencies that supply us with tissue. We are party to a multi-year agreement with
AlloSource, a non-profit tissue procurement organization, for the supply by AlloSource to us of tissue for use in the manufacture of Osteocel. AlloSource has committed to to provide bone
matrix to us for use in the production of Osteocel, and to ensure that the technology is made available to the communities from which it is sourced, the agreement enables AlloSource to act as a
non-exclusive distributor of Osteocel in AlloSource's donor communities. Recently, we entered into a multi-year agreement with Tissue Banks International (TBI), a
non-profit tissue procurement organization for the supply by TBI to us of tissue for use in the manufacture of Osteocel. Under the terms of the agreement, TBI has committed to provide bone
matrix to us for use in the manufacture of Osteocel, and to ensure that the technology is made available to the communities from which it is sourced, the agreement enables TBI also to act as a
non-exclusive distributor of Osteocel in TBI's local donor communities.

We
believe that Osteocel is properly characterized, and regulated by the FDA, as a HCT/P under section 361 of the Public Health Service Act.

We
are in the process of developing a second generation MSC product for bone repair, Osteocel-XC, as a long-term strategy to relieve supply
constraints. Unlike Osteocel, Osteocel-XC will utilize culture-expanded MSCs like our other biologic drug candidates. Based on our clinical and preclinical experience with Osteocel and
MSCs, we are preparing to submit an Investigational New Drug application to FDA to study Osteocel-XC.

Revenues
from sales of Osteocel were $15.2 million in fiscal 2007, $8.3 million in fiscal 2006 and $1.0 million in fiscal 2005.

Clinical Programs

Prochymal

Prochymal is our biologic drug candidate that is being used to treat medical conditions in a variety of indications. Prochymal is being evaluated in
Phase III clinical trials for three indications, including first line and steroid refractory acute Graft versus Host Disease (GvHD) and Crohn's disease, and is the only stem cell therapeutic
currently designated by the FDA as both an Orphan Drug and Fast Track product. Prochymal is also being developed for the repair of heart tissue following a heart attack and for the protection of
pancreatic islet cells in patients with type 1 diabetes. We are also developing Prochymal as a medical countermeasure to nuclear terrorism and other radiological countermeasures.

Graft versus Host Disease

GvHD is a life threatening immune system reaction that commonly affects the skin, gastrointestinal tract, and liver in patients who have received a bone marrow
transplant. We estimate that there are approximately 3,000 instances of GvHD in the United States each year.

Bone
marrow transplantation is a treatment of last resort for patients with certain cancers and some genetic diseases. This procedure can result in a particularly serious type of
rejection referred to as acute GvHD. This condition gets its name because the bone marrow transplant, or the graft, begins to attack the recipient, or the host. As noted in an article published in the
journalBiology of Blood and Marrow Transplantationin 2005, acute GvHD is one of the most common complications of allogeneic bone marrow or
hematopoietic stem cell transplantation, affecting approximately 50% of transplant patients. Acute GvHD is graded for prognostic and treatment purposes on a four grade scale, with Grade I considered
mild, Grade II moderate, and Grades III-IV considered severe and life-threatening. The onset of GvHD in patients who have received a bone marrow transplant leads to a poor
prognosis because of the already weakened state of such patients. According to a 2002 article published inBiology

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of Blood and Marrow Transplantation, the estimated one-year survival rate for patients with acute GvHD decreases drastically with increasing disease severity, as
illustrated below:

Acute GvHD

Estimated One Year SurvivalGrade I

65%Grade II

60%Grade III

39%Grade IV

22%


Typically,
patients are treated aggressively with steroids when their GvHD reaches Grade II. A 2001 article published in the journalBloodnoted that approximately 50% of these patients will not respond to treatment with steroids and approximately 50-80% of steroid refractory GvHD patients die of the disease.

The
current treatments available for acute GvHD are inadequate in several ways. First, mortality in patients with acute GvHD is unacceptably high. Second, most treatments for acute GvHD
work by suppressing or destroying the immune system. This leads to a number of debilitating side effects, including severe and life threatening infection. Unlike steroids or other immunosuppressant
drugs, which have a systemic effect, Prochymal's mechanism of action is designed to specifically target areas of inflammation. Therefore, we believe the use of Prochymal will result in a lower rate of
life threatening infection.

We
are currently enrolling patients in two Phase III pivotal trials for acute GvHD and have been granted Fast Track status by FDA for both. The first Phase III trial is
investigating Prochymal in patients with steroid refractory GvHD. Approximately 80 sites in the United States, Canada, Europe and Australia are participating in this trial. The second Phase III
trial is evaluating Prochymal as a first line treatment for acute GvHD and is taking place in approximately 50 leading centers in the United States and Canada.

A
program is also ongoing to provide Prochymal in a compassionate use setting for pediatric patients with severe treatment refractory acute GvHD and no remaining treatment options. At
the end of 2007, data was reported for a total of twelve pediatric patients between five months and fifteen years of age suffering from severe (Grade III/IV) acute GvHD. These patients had failed, on
average, 3.2 lines of therapy prior to treatment with Prochymal. Patients received a median of eight infusions of Prochymal
(range 3-21) at a dose of 2 million cells per kilogram of body weight. All patients (12/12) experienced an objective clinical response to therapy, with 58%
(7/12) of patients achieving a complete resolution of their GvHD. The 100 day survival was also 58% (7/12) and directly correlated with response rate. There were
no infusional toxicities associated with the administration of Prochymal. This pediatric compassionate use program for Prochymal is ongoing.

We
completed a Phase II trial evaluating Prochymal as a first-line treatment in combination with steroids, for patients diagnosed with Grade II through Grade IV acute
GvHD. A total of 32 patients were treated with two infusions of Prochymal, administered 72 hours apart. The treatment commenced within 48 hours of GvHD diagnosis. In this study, we were
evaluating safety, dose and response to treatment by day 28. When Prochymal was added to steroid therapy, patients were twice as likely to have total clinical resolution of their disease compared to
reported results for steroid only treatment. Twenty-nine of 31 patients, or 94% responded after receiving two infusions of Prochymal, with 24 patients, or 77% achieving a complete
response, meaning the patients had experienced total clinical resolution of the disease. At six months, 61% of all patients treated with Prochymal still had a durable response requiring no additional
use. Furthermore, 95% of patients achieving a durable response were alive at six months.

Beginning
in 2004, several requests were made by physicians to use Prochymal in a compassionate use setting for patients with acute severe treatment refractory GvHD and no remaining
treatment

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options.
Both pediatric and adult patients that had failed to respond to steroids and other immunosuppressive agents were treated on an emergency-use basis, and clinical improvements were
seen in gastrointestinal and skin GvHD. Patients were treated with Prochymal every 72 hours as needed for response, for a maximum of eight treatments. Fourteen patients were treated and had
failed to respond to an average of 4.4 other drug therapies prior to treatment with Prochymal. A 59% Prochymal response rate was observed in this treatment refractory population, defined as an
improvement in at least one affected organ by at least one full GvHD stage without disease progression in any other organ. Because the patients in this trial had previously not responded to multiple
lines of therapy and their condition was immediately life threatening, for ethical reasons the use of a placebo control was not possible. Therefore, further analysis of the statistical significance of
our results was not performed.

In
2003 we completed a Phase I trial to determine the safety of Prochymal in patients who received hematopoietic stem cell transplants. The trial investigated patient response to
three different doses of Prochymal. No safety concerns related to the use of Prochymal were observed in the 46 subjects who were evaluated.

We
obtained both Fast Track and Orphan Drug designation in 2005 for the use of Prochymal in GvHD patients. The FDA grants Fast Track designation to investigational drugs that have the
potential to treat life-threatening diseases with unmet medical needs. Our Biologic License Application will be eligible for an expedited review process by the FDA as a result of this
designation. Orphan Drug designation offers several benefits including eligibility for grants to fund studies,, up to seven
years of marketing exclusivity and a waiver of the Biologic License Application fee of approximately $900,000. Prochymal is the only stem cell therapeutic currently designated by the FDA as both an
Orphan Drug and Fast Track product candidate.

Crohn's Disease

Based on our clinical observations of the effects of Prochymal on the gastrointestinal symptoms of patients with GvHD, we are developing Prochymal for the
treatment of Crohn's disease. Crohn's disease is a chronic, life-long condition that features relapsing inflammation of the gastrointestinal tract. Severe Crohn's disease can cause
intractable diarrhea and abdominal pain, undesirable changes in lifestyle, hospitalization, and unwanted side effects from required medications. Approximately 60% of Crohn's disease patients require
at least one surgery to remove an affected portion of their intestine at some time during their lifetime, according to a 2002 article in the journalAlimentary
Pharmacology & Therapeutics. This article further notes that there are over 500,000 cases of diagnosed Crohn's disease in the United States, and at any given time
approximately 10% of these cases have a severe exacerbation or relapse that does not respond to traditional immunosuppressive treatments. Standard treatments of steroids and other immune suppressants
often cause secondary health problems. According to a 2003 article in theBritish Journal of Clinical Pharmacology, with current medical therapies about
50% of patients with severe Crohn's disease will relapse within one year.

We
completed a Phase II trial studying Prochymal as a treatment for moderate to severe Crohn's disease that is refractory to steroids and other immune suppressants. We enrolled
ten patients in this study and communicated the results during the October 2006 annual meeting of the American College of Gastroenterology. The trial was a prospective, randomized, open label trial,
conducted at 4 leading centers in the United States. Patients with moderate to severe Crohn's disease, defined as having a Crohn's Disease Activity Index (CDAI) of at least 220, who had previously
failed treatment with steroids and other immunosuppressive agents, were given two infusions of Prochymal seven days apart. A total of ten patients were treated and nine patients were evaluated through
the 28 day follow-up. One patient elected to exit the trial prior to completion. Patients were assigned to one of two treatment groups and received Prochymal on an outpatient basis.
In addition to safety parameters, patients were evaluated for changes in CDAI and improvement in the Inflammatory Bowel Disease

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Questionnaire
(IBDQ). Prior to entering the trial, patients who had been treated with infliximab or other biological agents were required to complete a washout period of 90 days to preclude the
possibility that response was the result of a previous treatment.

Entering
the trial, the average CDAI score at baseline was 341. Patients entering this study had suffered from Crohn's disease for an average of 14.2 years, and 80% of the
patients required prior surgical intervention to treat their Crohn's disease. In the study, one-third of the patients had a reduction of CDAI of greater than 100 points within
14 days of treatment. Each of these
responders had failed previous treatment with infliximab (Remicade(R)). Mean IBDQ scores improved significantly from baseline to day 28 (113 to 146, p=0.008). One-third of the patients
reported IBDQ scores of at least 170, indicating they had achieved clinical remission of their disease. Although not reaching statistical significance, there appeared to be correlation between dose
and response. Patients receiving the high dose had a 72-point greater reduction in CDAI than those receiving low dose (CDAI reduction of 137 vs. 65). There were no infusional toxicities,
and no treatment-related severe adverse events.

As
a result of the encouraging data, we are enrolling patients in a Phase III trial evaluating Prochymal for the treatment of moderate to severe Crohn's disease that is refractory
to biological therapy. The study is designed to enroll up to 258 patients and is double blind, placebo controlled, and includes patients, 18 to 70 years of age, with a Crohn's Disease Activity
Index ("CDAI") greater than 250. The primary endpoint of this trial is the proportion of patients with CDAI of less than 150 (clinical remission) at day 28. The study is being conducted at 50 leading
centers in the United States and Canada. We have received Fast Track designation from the FDA, which makes us eligible for expedited FDA review of Prochymal for this indication.

Acute Myocardial Infarction

We are also evaluating Prochymal for the repair of heart muscle in patients who have suffered a heart attack. Preclinical studies indicate that Prochymal prevents
scar formation that typically occurs after a heart attack and improves cardiac function eight to ten weeks after its administration. As discussed further below, we completed enrollment in a
Phase I clinical trial for Prochymal in March, 2006. This trial is designed to evaluate the safety and efficacy of Prochymal to restore heart function in patients experiencing a first time
heart attack.

A
heart attack, or acute myocardial infarction (AMI), occurs when coronary arteries become blocked with fatty deposits, depriving the heart muscle of oxygen and nutrients. Based on
statistics published in 2005 by the American Stroke Association and the American Heart Association, in the United States approximately 700,000 individuals each year experience their first heart
attack. According to these same statistics, approximately 20% of patients experiencing their first heart attack suffer extensive damage to their heart muscle, leading to heart failure within six
years. Furthermore, we believe the statistics indicate that despite improvements in the standard of care, this progression from myocardial infarction to heart failure remains largely unavoidable in
patients with AMIs.

Prochymal
is being developed for the treatment of heart muscle damage following AMI. Its primary indication is to treat post-AMI complications and prevent the formation of
scar tissue and associated cardiac dysfunction. Our preclinical studies indicate that the mechanism by which Prochymal improves myocardial function includes the prevention of pathological scarring of
the heart muscle and the formation of new blood vessels. We are developing Prochymal as a therapy to be delivered through a standard intravenous line up to 10 days post-myocardial
infarction.

In
preclinical studies, Prochymal selectively targeted the damaged area of the heart when a single infusion was administered. These studies also indicated that Prochymal has the effect
of retarding or stopping the progression of further cardiac tissue deterioration and limiting the damage caused by an AMI. Significant improvements in cardiac function as demonstrated by increased
ejection fraction, reduced end diastolic pressures, and reduced wall stress were observed eight to ten weeks after

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administration
of Prochymal. A preclinical study was performed to determine if an intravenous infusion of MSCs following myocardial infarction would result in an improvement in cardiac function.
Significant improvement in cardiac function as indicated by left ventricular ejection fraction was observed three months after infarct in those animals receiving intravenous delivery of MSCs compared
to control animals. MSCs were detected in the damaged area of the heart muscle of Prochymal treated animals, but not in the remote, undamaged regions.

In
March 2006, we completed enrollment of a 53-patient Phase I randomized, double blind, placebo controlled clinical study to evaluate Prochymal in patients following
AMI. The trial was designed to investigate patient response to three different doses of Prochymal or placebo. Exploratory efficacy endpoints included overall improvement in the function and remodeling
of the heart muscle six months after treatment. A safety evaluation for each subject will be conducted two years after the subject is enrolled in the trial.

In
March 2007, we reported six-month results in this trial. Heart attack patients receiving Prochymal had significantly lower rates of adverse events, such as cardiac
arrhythmias, as well as significant improvements in heart, lung and global function. Administration of Prochymal was found to be well tolerated at all dose levels. Patients in the Prochymal group were
four times less likely to experience an arrhythmic event compared to those receiving placebo (9% vs. 37%, p=0.025). Fewer patients experienced clinically significant premature ventricular contractions
after receiving Prochymal as compared to placebo at the one month (6% vs. 32%, p < 0.05) and two month (9% vs. 38%, p < 0.05) time points. Patients with anterior wall myocardial
infarctions had a statistically significant 7.0 point (24%) improvement in ejection fraction at three months and a 7.3 point (25%) improvement at six months over baseline (p<0.05). In
comparison, placebo patients in this group did not have a significant increase. Patients receiving Prochymal had significantly improved pulmonary function as measured by improvement in FEV1% predicted
values (17 point Prochymal vs. 6 point placebo, p<0.05). Significantly more patients who received Prochymal experienced improvement in their overall condition at six months as compared to
those receiving placebo (42% vs. 11%, p=0.027).

In
February 2008, we reported interim results at the one-year time point in the Phase I trial. The trial continued to demonstrate Prochymal's strong safety profile as
well as continued statistically significant improvement in heart function. One year magnetic resonance imaging (MRI) data on left ventricular ejection fraction (LVEF) was collected and patients
treated with Prochymal showed a statistically significant 5.2 point increase over baseline (p=0.021). Patients receiving placebo showed only a 1.8-point improvement over baseline, which
was not statistically significant. Patients with more severe myocardial infarction, defined as a baseline LVEF of 45 or less, demonstrated even greater effects. The Prochymal treatment group showed a
6.5-point
improvement one year post-treatment, compared to a 1.9-point increase in the placebo group. Prochymal treated patients continued to experience fewer adverse events at a rate of
6.1 per patient, compared to 8.0 per patient in the placebo group. This one-year interim analysis was performed as a part of the full two-year follow-up, and as a
result, contains only limited data.

Based
upon the positive results from the Phase I trial, we received approval from the FDA to initiate a Phase II trial.

Type 1 Diabetes

We are also investigating Prochymal as a treatment for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus.
Type 1 diabetes, commonly known as juvenile diabetes or insulin-dependent diabetes, is an autoimmune disorder that attacks and destroys insulin producing islet cells in the pancreas causing
glucose accumulation in the blood. As a result, those suffering from type 1 diabetes must take insulin to regulate blood sugar levels. Over time, poorly controlled diabetes can lead to serious
health conditions, including heart disease, stroke, blindness, amputations, kidney disease and nerve damage. Currently, there are no preventative measures for

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type 1
diabetes. In preclinical research, both animal and human bone marrow-derived mesenchymal stem cells (MSCs) were shown to preserve beta cell function in animal models of diabetes.

In
October 2007, we reported the initiation of a Phase II trial evaluating the safety and efficacy of Prochymal in conjunction with standard of care in preserving insulin
production in patients recently diagnosed with type 1 diabetes mellitus. The trial is double-blind, placebo-controlled and will target the enrollment of 60 patients. Patients in the study will
receive three intravenous infusions of Prochymal over the course of sixty days. The primary endpoint of the trial is the measurement of C-peptide produced during a Mixed Meal Tolerance
Test in patients treated with Prochymal, compared to those receiving placebo. This test is frequently used in diabetic patients to determine how much insulin is being produced by the pancreas in
response to glucose stimulation. The patients in the trial will be followed for safety and efficacy for two years

Chondrogen

Chondrogen is our biologic drug candidate for regeneration of meniscus, a type of cartilage that cushions the knee joint. There are currently no FDA approved
products available to regenerate meniscal tissue. In several preclinical studies, Chondrogen, a preparation of adult stem cells formulated
for direct injection into the knee, regenerated meniscus and prevented osteoarthritis in animal models. As described further below, at the end of the first quarter of 2006 we completed enrollment in a
Phase I/II clinical trial for Chondrogen, designed to evaluate the safety and preliminary efficacy in patients following surgery to remove torn meniscus.

The
meniscus is a crescent-shaped cushion in the knee joint that protects cartilage and enables the knee to move smoothly. Injury and tears to the meniscus are common and can be
traumatic, arising from sports injury for example, or degenerative, due to daily wear and tear. An injured or torn meniscus is painful and typically requires surgical intervention. The current
standard of care for significant injuries is partial meniscectomy surgery, in which the damaged portion of the meniscus is permanently removed. According to a 2005 article in the American Journal of Sports
Medicine, approximately 1.0 million people have surgery to remove damaged or torn meniscus in the United States each
year. As noted in a 1999 article in the journalSports Medicine, patients who have had this procedure are 10 to 15 times more likely to develop
osteoarthritis, a highly debilitating orthopedic condition. As a result, a significant medical need exists for a product that can regenerate the meniscal tissue removed during surgery and prevent
cartilage degeneration.

At
the end of the first quarter of 2006, we completed a randomized double-blind, placebo controlled Phase I/II clinical trial evaluating Chondrogen for safety and preliminary
efficacy based upon regeneration of meniscus at six-months. We plan on evaluating each patient for safety two years after the patient enrolled in the trial. Participants in the trial
received one of two doses of Chondrogen or placebo, and a total of 55 patients were treated. At the six-month time point, Chondrogen met its primary endpoint, demonstrating product safety.
An initial review of the data showed that Chondrogen was well tolerated, was not associated with serious adverse events, did not result in any adverse hematological events, and did not result in the
formation of any unwanted or ectopic tissue. There was no significant change in the volume of meniscus on MRI at six-months in patients that received Chondrogen compared to those patients
receiving placebo. However, about 30% of patients treated with Chondrogen demonstrated an improvement in their baseline cartilage or joint condition, while no patients in the placebo group
demonstrated similar improvement.

In
November 2007, we reported one-year data for the Phase I/II Chondrogen trial. The data continued to show improvements in joint condition that correlated with a
clinically and statistically significant improvement in pain in patients with osteoarthritis (OA) who received Chondrogen as compared to those treated with the control, hyaluronic acid (HA). Patients
receiving the control were 3.5 times more likely to experience degenerative bone changes associated with OA as compared to those receiving Chondrogen. The effects were dose dependent and pain scores
improved from six

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months
to one year following treatment, suggesting Chondrogen caused a biological modification of patients' OA. Patients will be followed for safety and additional preliminary efficacy, such as
cartilage damage and changes in the meniscus for two years under the current study protocol.

Collaborations

JCR Pharmaceuticals Co., Ltd.License Agreement

In August 2003, we entered into a license agreement with JCR Pharmaceuticals Co., Ltd. ("JCR"), pursuant to which we granted to JCR an exclusive
right in Japan to our MSC technology for use in connection with the use of hematopoietic stem cells derived from peripheral blood, cord blood or bone marrow in the treatment of hematological
malignancies.

The
license agreement provided for a payment by JCR to us of an up-front license fee of $3.0 million and payment of an additional $0.5 million upon certain
technology transfer. In addition, if and when marketing approval is obtained in Japan, JCR is required to pay up to $7.0 million in pre-commercialization milestones per product and
certain amounts for pre-determined thresholds of cumulative net sales. Lastly, JCR has an obligation to pay royalties to us, with such amount dependent upon the cumulative net sales. We
received a $0.5 million milestone payment in 2007 when JCR filed an IND in Japan.

Under
the terms of the collaborative arrangement, JCR will bear all costs associated with bringing the drug to market in Japan. JCR is obligated to use its reasonable best efforts to
develop and commercialize in Japan products covered under the terms of the license, including conducting clinical trials and procuring regulatory and other approvals. The license expires with respect
to specific products on the later of 15 years from the date of the first sale of the product in Japan or the date on which our last patent in Japan covering that product expires. Also, the
license and the collaboration can be terminated unilaterally by JCR upon 180 days notice to us or by mutual agreement between us and JCR.

In
conjunction with this collaboration, JCR made a $3.0 million investment in our preferred stock, which converted at the closing of our initial public offering into 136,363
shares of our common stock.

Genzyme CorporationCollaboration Agreement

In July, 2007, we entered into an agreement with Genzyme Corporation for collaboration in the preparation and execution of development and purchase agreements
with United States and Allied government agencies for countermeasures to nuclear terrorism and other radiological emergencies. In
January 2008, we were awarded a contract from the United States Department of Defense ("DoD") for the development and stockpiling of Prochymal for the treatment of Acute Radiation Syndrome ("ARS").
Under the terms of the contract, the DoD will provide technology and product development funding to us in two stages, with an initial amount of $4.2 million expected to be earned in 2008. The
contract further provides for additional funding for activities leading to FDA approval of Prochymal for ARS and the scaling up of manufacturing processes, and provides the DoD with successive options
for the purchase of up to 20,000 doses of Prochymal in the aggregate. The total value of the contract, assuming FDA approval and the exercise by the DoD of all of its options to purchase doses of
Prochymal at current prices ($10,000 per dose), is up to $224.7 million. We will carry out this contract in partnership with Genzyme, with us contributing Prochymal and our corresponding safety
and advocacy database to the effort, and with Genzyme lending its mass product development and large scale commercialization expertise. Our agreement with Genzyme provides for Genzyme to receive a
royalty of 15% of net product sales, limited to those sales made under contracts with United States or Allied government agencies for emergency preparedness.

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Juvenile Diabetes Research FoundationCollaborative Agreement

In October 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation ("JDRF") for the development of Prochymal as a treatment
for the preservation of insulin production in patients with newly diagnosed type 1 diabetes. Under the terms of the agreement, JDRF has agreed to fund $4.0 million of the research costs,
payable to us based upon the achievement of established milestones. We expect to earn $2.0 million during 2008 from the agreement, and $2.0 million during 2009.

Blackstone Medical, Inc.Distribution Agreement

In November 2005, we entered into a distribution and supply arrangement for Osteocel with Blackstone Medical, Inc., or Blackstone. Blackstone has since
been acquired and now operates as a division of Orthofix International, N.V. Blackstone has the right to distribute Osteocel in the United States for the treatment of spinal injuries or
diseases. In addition, we granted Blackstone an exclusive distribution right with regard to spinal implant manufacturers provided that it commits to purchase at least 80% of the quarterly production
forecast of Osteocel at a stipulated price per unit.

Blackstone
markets Osteocel under the "Trinity" name. We have also retained the right to directly market and distribute Osteocel under the Osteocel brand.

Blackstone
is required to use its best efforts to distribute Osteocel. Unless earlier terminated, the agreement terminates on December 31, 2008; however, it can be renewed for
one-year periods so long as Blackstone achieves certain predetermined performance objectives.

Either
party may terminate the agreement immediately upon written notice to the other party of the occurrence of certain bankruptcy events or failure to remedy a material breach that
continues for more than 30 days.

Boston Scientific CorporationResearch, Development and Commercialization Collaboration

In March 2003, we entered into a collaboration agreement with Boston Scientific Corporation, or Boston Scientific, to develop applications of our MSC technology
to treat acute myocardial infarction and chronic ischemia. In connection with this collaboration, we granted to Boston Scientific a worldwide, exclusive license to develop, market and distribute MSC
products in the covered field.

Boston
Scientific paid a $5.0 million licensing fee to us upon the effectiveness of the license, and lent us $5.0 million under a line of credit that was established in
connection with the collaborative agreement. In conjunction with this collaboration, Boston Scientific made a $10.0 million investment in our preferred stock, which converted at the closing of
our initial public offering into 500,000 shares of our common stock.

In
December 2007, we terminated the research, development and commercialization collaborative agreements with Boston Scientific and regained the worldwide rights to cardiac indications.
Upon termination of the agreements, the outstanding amounts due under the line of credit, together with accrued interest were converted into a one-year 8% promissory note which is payable
in quarterly installments beginning in January 2008.

Intellectual Property

We have established a considerable patent position in adult stem cell technology. We currently own or have exclusive licenses to approximately 47 issued U.S.
patents. Foreign counterparts to these patents, including composition of matter claims, have been filed, and we own or hold licenses to approximately 253 issued patents in Europe, Canada, Australia
and other countries. The patents and patent licenses included in our portfolio address the composition and therapeutic use of mesenchymal

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stem
cells. We are committed to protecting our intellectual property position and to aggressively pursue our patent portfolio, and have approximately 13 additional U.S. patent applications pending and
approximately 59 foreign patent applications on file but not yet allowed. For most of our biologic drug candidates, we rely on multiple patents in combination.

Through
our experience with MSCs and MSC-based product development, we have developed expertise and know-how in this field. We manufacture clinical grade MSCs
in-house and contract for the production through contract manufacturers. To protect this non-patentable know-how, our policies require confidentiality agreements
with our employees, consultants, contractors, manufacturers, outside collaborators, sponsored researchers, and advisors. These agreements generally provide for protection of confidential information,
restrictions on the use of materials and assignment of inventions conceived during the course of performance for us. These agreements might not effectively prevent disclosure of our confidential
information.

We
were founded on the basis of MSC technology obtained from Case Western Reserve University, or CWRU. In January 1993, we entered into a Technology Transfer and License Agreement with
CWRU, which was subsequently amended in October 1999 and twice in October 2003. Pursuant to this license agreement certain patents were assigned to us and others were exclusively licensed to us, with
the right to grant sublicenses.

The
exclusive license is subject to any rights of a governmental agency based on research funding by such an agency, and to CWRU's retained rights under the patents for
non-clinical research, testing or educational purposes of CWRU.

With
respect to the patents licensed to us, we are obligated to pay royalties to CWRU based on sales of products covered by granted licensed patents, and such royalties commence with
respect to each such product on the third anniversary of the initial sale thereof. We are also obligated to pay minimum royalties under the agreement with CWRU. We are responsible for patent costs and
along with CWRU have the right to enforce licensed patents. The license is terminable by CWRU in the event that there is a material breach by us. Otherwise the license is for the life of the patents.
Under certain circumstances, we are obligated to negotiate in good faith with a third party a sublicense under patents licensed from CWRU and under patents and know-how owned by us that
are reasonably required by the third party to exercise the granted sublicense. We are not obligated to grant such a sublicense where it would have a potential adverse effect on a product being
researched, developed or commercialized by us or by a licensee or sub licensee of ours.

Under
terms of a Marketing, Collaboration and License Agreement with Lonza, we have licensed our MSC technology to Lonza to sell MSCs, the MSC descendants, cells produced from MSCs and
materials used with MSCs for commercial and non-commercial research purposes. Under the terms of this agreement, Lonza is specifically precluded from selling the licensed products for use
in humans. We receive royalties on any sales under this agreement.

Patent
life determination depends on the date of filing of the application or the date of patent issuance and other factors as promulgated under patent law. The United States Drug Price
Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Act, permits a patent extension of up to five years as compensation for patent term lost during the FDA regulatory review
process. The patent term restoration period is generally one-half the time between the effective date of an Investigational New Drug Application or IND and the submission date of a New
Drug Application or NDA, plus the time between the submission date of an NDA and the approval of the drug. Only the earliest patent applicable to an approved drug is eligible for the extension. The
United States Patent and Trademark Office, in consultation with the FDA, reviews and approves applications for patent term extension. We expect to apply for patent term extensions for eligible patents
to add
patent life beyond the expiration date, depending on the expected length of clinical trials and other factors involved in the filing of a new drug application.

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Manufacturing

Production of Biologic Drug Candidates

We believe that we have differentiated ourselves from other stem cell companies through proprietary manufacturing methods that allow for the controlled growth of
MSCs to produce up to 10,000 treatments of our biologic drug candidates from a single bone marrow donation. This is in contrast to most other stem cell technologies that are able to make only a single
treatment from each donation.

We
have been manufacturing mesenchymal stem cells for over nine years. The first material manufactured in-house was released in 1999. Since that time manufacturing has
continued to improve in support of clinical trials. The current manufacturing process utilizes cell factories, a closed system of surfaces on which the cells adhere, for stem cell expansion. We have
developed this technology into a reproducible process that can be scaled up at additional sites. A second manufacturing site was successfully qualified in 2003. In addition, JCR Pharmaceuticals, our
partner in Japan, has successfully implemented our manufacturing technology in Japan. We believe that we perform all of our manufacturing activities in compliance with the FDA's current Good
Manufacturing Practice requirements.

Our
manufacturing process begins with the collection of bone marrow aspirate from qualified volunteer donors, 18-30 years of age. Prior to donation, these individuals
are screened and tested for a battery of diseases including HIV and hepatitis according to the FDA's donor suitability guidance. We purchase bone marrow aspirate from commercial sources. Since the
mesenchymal stem cell is extremely rare, accounting for only one in every 100,000 cells in bone marrow, an initial purification process is required. Upon arrival at our facilities, MSCs are isolated
and selectively removed from the bone marrow through a multi-step process. A beneficial feature of our stem cells is that they adhere to the surface of the cell factory and the other remaining cell
populations do not adhere and are washed away throughout the process. Our stem cells are then expanded, harvested, packaged and cryopreserved as an in-process intermediate, and we conduct
a second battery of quality testing. Each packaged intermediate is further expanded and formulated to produce the final product. Sterility and
quality testing completes the process. This well-defined process has allowed for the development of a supply chain where material specifications have been established and vendors have been
qualified.

The
final product will be configured to allow for ease of storage, distribution and use in the clinic. We expect the product will be provided in ready-to-use
patient dose quantities, shipped from the distribution center on dry ice, and stored in the freezer at the pharmacy.

Production of Osteocel

Osteocel is a matrix of viable cancellous bone containing primary or unexpanded MSCs. Unlike our biologic drug candidates, the stem cells and cancellous bone used
in Osteocel are obtained from organ and tissue donors. Additionally, the production of Osteocel is different from our biologic drug candidates in that it does not feature the expansion of MSCs.

Since
its introduction into the marketplace in July 2005, we have been unable to produce Osteocel in quantities sufficient to meet our customer demand due to constraints in our
manufacturing facility and the lack of sufficient quantities of marrow-rich bone. We contract with tissue recovery agencies for Osteocel source tissue. We currently have ten agencies under
contract, including Allosource as discussed above. These agencies in turn have contracts with federally designated Organ Procurement Organizations who notify the agencies of donor candidates in their
areas. Once an initial qualification of the donor is performed, a surgical team is deployed to remove the tissue and send it to our processing center via overnight delivery. The agencies also compile
the donor's medical records, perform a medical and social history evaluation, collect serum samples for serological testing and

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perform
other donor screening services. These agencies operate on a fee-for-service basis, which varies depending upon the tissue type and transplant suitability. We intend to
enter into contracts with additional tissue recovery agencies in the future in order to fulfill product demand. We expect to continue to increase manufacturing capacities in line with tissue supply,
and believe we will eventually be limited by available donor material regardless of manufacturing capacity.

The
processing of Osteocel is in many ways more like the process of organ donation than standard tissue processing. This is because it is essential that the stem cells contained within
Osteocel are kept in a living, healthy state. We overcome this challenge through a proprietary process that is designed to preserve the material, particularly the stem cells. Sterility cultures are
performed on the final product from every lot according to United States Pharmacopeia standards. Following completion of quality control testing and quality assurance review, the product is released
for distribution.

Sales, Marketing and Distribution

Our current sales network consists of approximately 45 independent sales representatives and a distribution agreement with Blackstone Medical, Inc., and
its affiliates, for the distribution of Osteocel. In addition, to ensure that Osteocel is made available to the communities from which it is sourced, our agreements with AlloSource and Tissue Banks
International enables these agencies to act as a non-exclusive distributor of Osteocel in their local donor communities.

To
increase Osteocel's market penetration, we intend to further expand our network of sales professionals in the United States. We intend to self commercialize all of our biologic drug
candidates in the United States upon FDA approval through the creation of additional sales and marketing capabilities in existing and new indications and the leverage of Osteocel's sales and marketing
infrastructure for orthopedic indications. We have entered into a collaborative arrangement with JCR Pharmaceuticals Co., Ltd. for the distribution of Prochymal for GvHD in Japan
following marketing approval.

Both
our Osteocel product and our biologic drug candidates have long-term storage requirements within specific frozen temperature ranges, -80 degrees Centigrade
and -140 degrees Centigrade, respectively. Generally, we do not believe this will pose a significant problem for end-users as most hospitals and medical centers have freezers
with these storage capabilities readily available. However, some facilities may not have this type of storage available and this may limit product and biologic drug candidate distribution. In an
effort to mitigate potential issues with product and biologic drug candidate storage, we are performing studies to develop less restrictive storage temperatures. For example, we have implemented
temporary -50 degree Centigrade storage of Osteocel for up to two weeks, which opens distribution to a wider hospital base.

Osteocel

Our marketing of Osteocel is targeted to orthopedic surgeons and neurosurgeons practicing in the United States. The most rapid adoption rates to date have been
for spinal fusion procedures. Osteocel is currently distributed by our corporate partner, Blackstone Medical, Inc., and its affiliates, and is also distributed by AlloSource, Tissue Banks
International and for us by an independent network of approximately 45 sales representatives. Blackstone is a designer and manufacturer of spinal instruments and implants located in Massachusetts. In
the field of orthopedics, we intend to continue to develop a network of sales professionals for the distribution of Osteocel.

Prochymal

Upon FDA approval of Prochymal for GvHD indications, we expect to focus our sales and marketing efforts on the approximately 210 transplantation hospitals in the
United States that are registered with the International Bone Marrow Transplantation Registry. We expect to employ a

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number
of sales representatives, initially targeting the most active transplantation centers in a region. An important component of the sales strategy will be to gain the support of key opinion
leaders, facilitating the adoption of Prochymal as the treatment strategy for GvHD. We have entered into a license agreement with JCR Pharmaceuticals that grants it the exclusive right to distribute
Prochymal for the treatment of GvHD in Japan when it has been approved for marketing in that country.

Competition

Our industry is subject to rapid and intense technological change. We face, and will continue to face, intense competition from pharmaceutical, biopharmaceutical
and biotechnology companies, as well as numerous academic and research institutions and governmental agencies engaged in drug discovery activities or funding, both in the U.S. and abroad. Some of
these competitors are pursuing the development of drugs and other therapies that target the same diseases and conditions that we target in our commercial, clinical and preclinical programs.

Many
of the companies competing against us have financial and other resources substantially greater than our own. In addition, many of our competitors have significantly greater
experience in testing pharmaceutical and other therapeutic products, obtaining FDA and other regulatory approvals of products, and marketing and selling those products. Accordingly, our competitors
may succeed more rapidly than we will in obtaining FDA approval for products and achieving widespread market acceptance. If we obtain necessary regulatory approval and commence significant commercial
sales of our products, we will also be competing with respect to manufacturing efficiency and marketing capabilities, areas in which we have limited or no commercial-scale experience.

Our
commercialized product, Osteocel, currently competes with established treatment options such as autograft bone and Medtronic's INFUSE® and potentially may compete with
other products currently in development for the same indications. Our two biologic drug candidates, if approved, would compete with several marketed products and other future biologic drug candidates.
For our existing product and each of our clinical-stage biologic drug candidates, the primary competitors include:



We
may face competition in the future from other companies that are researching and developing stem cell therapies. We are aware of many companies working in this area, including:
Aastrom Biosciences, Advanced Cell Technology, Athersys, Cellerant Therapeutics, Cognate Therapeutics, Cytori Therapeutics, Gamida Cell, Geron, Mesoblast, MultiCell Technologies, Neuronyx, Theradigm,
ViaCell and StemCells.

We
expect to compete based upon, among other things, our intellectual property portfolio and the efficacy of our products. Our ability to compete successfully will depend on our
continued ability to attract and retain skilled and experienced scientific, clinical development and executive personnel, to

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identify
and develop viable biologic drug candidates and to exploit these products and compounds commercially before others are able to develop competitive products.

In
addition, our stem cell therapies may be expensive as compared to other therapies and this may make it more difficult for us to compete with other pharmaceuticals

Government Regulation

Regulation by governmental authorities in the United States and other countries is a significant factor in the development, manufacture, commercialization and
reimbursement of our products and services. Virtually all of the products we develop will require marketing approval, or licensure, by governmental agencies prior to commercialization. In particular,
human therapeutic products are subject to rigorous preclinical and clinical testing and other approval procedures of the U.S. Food and Drug Administration, or FDA, and similar regulatory authorities
in other countries. Various governmental statutes and regulations also govern or influence testing, manufacturing, safety, labeling, storage and record keeping related to such products and their
marketing. State, local and other authorities may also regulate pharmaceutical manufacturing facilities. The process of obtaining these approvals and the subsequent compliance with appropriate
statutes and regulations require the expenditure of substantial time and money, and there can be no guarantee that approvals will be granted.

FDA Approval Process

We believe that Osteocel is appropriately characterized as a product regulated by the FDA as a "human cells, tissues and cellular and tissue-based product," for
which the FDA does not require premarket approval. See the discussion below under the caption "Human Cellular and Tissue-Based Product." Our biologic drug candidates will require approval
from the FDA and corresponding agencies in other countries before they can be marketed. The FDA regulates human therapeutic products in one of three broad categories: biologics, drugs, or medical
devices. Our biologic drug candidates will be regulated as biological products. The FDA generally requires the following steps for premarket approval or licensure of a new biological product or new
drug product:



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Typically,
clinical testing involves a three-phase process although the phases may overlap. In Phase I, clinical trials are conducted with a small number of healthy volunteers or
patients and are designed to provide information about product safety and to evaluate the pattern of drug distribution and metabolism within the body. In Phase II, clinical trials are conducted
with groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and expanded evidence of safety. In some cases, an initial trial is conducted in
diseased patients to assess both preliminary efficacy and preliminary safety and patterns of drug metabolism and distribution, in which case it is referred to as a Phase I/II trial.
Phase III clinical trials are generally large-scale, multi-center, comparative trials conducted with patients afflicted with a target disease in order to provide statistically valid proof of
efficacy, as well as safety and potency. In some circumstances, the FDA may require Phase IV or post-marketing trials if it feels that additional information needs to be collected
about the drug after it is on the market. During all phases of clinical development, regulatory agencies require extensive monitoring and auditing of all clinical activities, clinical data and
clinical trial investigators. An agency may, at its discretion, re-evaluate, alter, suspend, or terminate
the testing based upon the data which have been accumulated to that point and its assessment of the risk/benefit ratio to the patient. Monitoring all aspects of the study to minimize risks is a
continuing process. All adverse events must be reported to the FDA.

The
results of the preclinical and clinical testing on a non-biologic drug and certain diagnostic drugs are submitted to the FDA in the NDA or BLA. In the case of vaccines or
gene and cell therapies, the results of clinical trials are submitted as a BLA. In responding to the submission of a BLA or NDA, the FDA may grant marketing authority, request additional clinical data
or deny approval if the FDA determines that the application does not satisfy its regulatory approval criteria. FDA review of a BLA or NDA typically takes one to three years, but may last longer,
especially if the FDA asks for more information or clarification of information already provided. Further clinical trials may be required to gain approval to promote the use of the product for any
additional indications. Such additional indications are obtained through the approval of a supplemental BLA or NDA.

The
process of obtaining regulatory approval is lengthy, uncertain, and requires the expenditure of substantial resources. Each NDA or BLA must be accompanied by a user fee, pursuant to
the requirements of the Prescription Drug User Fee Act, or PDUFA, and its amendments. The FDA adjusts the PDUFA user fees on an annual basis. According to the FDA's fee schedule, effective through
September 30, 2007, the user fee for an application requiring clinical data, such as an NDA or BLA, is $896,200. PDUFA also imposes an annual product fee for prescription drugs and biologics
($49,750), and an annual establishment fee ($313,100) on facilities used to manufacture prescription drugs and biologics. Fee waivers or reductions are available in certain circumstances, including a
waiver of the application fee for the first application filed by a small business. Additionally, no user fees are assessed on NDAs or BLAs for products designated as orphan drugs, unless the drug also
includes a non-orphan indication, and if a contract manufacturer is used, the contract manufacturer is responsible for the establishment fee.

Before
approving an NDA or BLA, all facilities and manufacturing techniques used for the manufacture of products must comply with applicable FDA regulations governing cGMP. A local field
division of the FDA is responsible for completing this inspection and providing recommendation for or against approval. This effort is intended to assure appropriate facility and process design to
avoid potentially lengthy delays in product approvals due to inspection deficiencies. Similarly, before approving a new drug or biologics application, the FDA may also conduct
pre-licensing inspections of a company, its contract research organizations and/or its clinical trial sites to ensure that clinical, safety, quality control and other regulated activities
are compliant with GCP. To assure such cGMP and GCP

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compliance,
the applicants must incur significant time, money and effort in the area of training, record keeping, production, and quality control. Following approval, the manufacture, holding, and
distribution of a product must continue to devote significant resources to maintain full compliance in these areas.

After
FDA approval has been obtained, the FDA will require post-marketing reporting to monitor the side effects of the drug. Further studies may be required to provide
additional data on
the product's risks, benefits, and optimal use, and will be required to gain approval for the use of the product as a treatment for clinical indications other than those for which the product was
initially tested. Results of post-marketing programs may limit or expand the further marketing of the product. Further, if there are any modifications to the drug, including changes in
indication, labeling, or a change in the manufacturing process or manufacturing facility, an NDA or BLA supplement may be required to be submitted to the FDA.

Additionally,
after the FDA has authorized a drug product to enter commercial distribution, numerous regulatory requirements apply. These include, among others, the cGMPs, which require
manufacturers to follow extensive design, testing, control, documentation and other quality assurance procedures during the manufacturing process; labeling regulations; the FDA's general prohibition
against promoting drug products for unapproved or off-label uses; and adverse event reporting regulations, which require that manufacturers report to the FDA if their drug may have caused
or contributed to a death or serious injury. The FDA has broad post-market and regulatory and enforcement powers. Failure to comply with the applicable U.S. drug regulatory requirements
could result in, among other things, warning letters, fines, injunctions, consent decrees, civil penalties, refunds, recalls or seizures of products (which would result in the cessation or reduction
of production volume), total or partial suspension of production, withdrawals or suspensions of current product applications, and criminal prosecution. Adverse events related to a drug product in any
existing or future markets could cause regulatory authorities to withdraw market approval for such product.

Fast Track and Orphan Drug Designations

Congress enacted the Food and Drug Administration Modernization Act of 1997 in part to ensure the availability of safe and effective drugs, biologics, and medical
devices by expediting the FDA review process for new products. The Modernization Act establishes a statutory program for the approval of Fast Track products, including biologics. A Fast Track product
is defined as a new drug or biologic intended for the treatment of a serious or life-threatening condition that demonstrates the potential to address unmet medical needs for this
condition. Under the Fast Track program, the sponsor of a new drug or biologic may request the FDA to designate the drug or biologic as a Fast Track product at any time during the clinical development
of the product. This designation assures access to FDA personnel for consultation throughout the development process and provides an opportunity to request priority review of a marketing application
providing a six-month review timeline for the designated product. If a preliminary review of the clinical data suggests that a Fast Track product may be effective, the FDA may initiate
review of sections of a marketing application for a Fast Track product before the sponsor completes the application. This rolling review is available if the applicant provides a schedule for
submission of remaining information and pays applicable user fees. However, the time periods specified under PDUFA concerning timing goals to which the FDA has committed in reviewing an application do
not begin until the sponsor submits the complete application. During the first quarter of 2005 the FDA designated Prochymal as a Fast Track product for the treatment of GvHD. Prochymal also received
Fast Track designation from the FDA in January 2007 for the treatment of refractory Crohn's disease. We cannot predict whether this designation will impact the timing or likelihood of FDA approval of
Prochymal.

The
Orphan Drug Act provides incentives to manufacturers to develop and market drugs for rare diseases and conditions affecting fewer than 200,000 persons in the United States at the
time of application for Orphan Drug designation. The first developer to receive FDA marketing approval for

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an
Orphan Drug is entitled to a seven year exclusive marketing period in the United States for that product as well as a waiver of the BLA user fee. However, a drug that the FDA considers to be
clinically superior to, or different from, another approved orphan drug, even though for the same indication, may also obtain approval in the United States during the seven year exclusive marketing
period. The FDA granted Orphan Drug designation for Prochymal during the last quarter of 2005.

Legislation
similar to the Orphan Drug Act has been enacted in countries other than the United States, including the European Union. The orphan legislation in the European Union is
available for therapies addressing conditions that affect five or fewer out of 10,000 persons. The marketing exclusivity period is for ten years, although that period can be reduced to six years if,
at the end of the fifth year, available evidence establishes that the product is sufficiently profitable not to justify maintenance of market exclusivity.

Human Cellular and Tissue-Based Product

Human cells or tissue intended for implantation, transplantation, infusion, or transfer into a human recipient is regulated by the FDA as human cells, tissues,
and cellular and tissue-based product, or HCT/Ps. We believe that Osteocel is appropriately characterized as an HCT/P and not as a biologic or drug. HCT/Ps are regulated differently from drug or
biologic products due to the fact they are minimally manipulated tissues intended for homologous use in the patient's body, are not combined with a drug, device or biologic, and do not have systemic
or metabolic effects on the body. The FDA does not require premarket approval for HCT/Ps, however, it does require strict adherence to federally mandated current Good Tissue Practice, or cGTP,
regulations. These regulations are analogous to the GMP regulations described above in terms of manufacturing standards. In addition, the FDA's regulations include other requirements to prevent the
introduction, transmission and spread of communicable disease. Specifically, the FDA's regulations require tissue establishments to register and list their HCT/Ps with the FDA and to evaluate donors
through screening and testing.

We
maintain state licensure as a human tissue bank in Maryland, California, Florida, Illinois and New York. These are the only states in which such licensure is required for us.

Privacy Law

Federal and state laws govern our ability to obtain and, in some cases, to use and disclose data we need to conduct research activities. Through the Health
Insurance Portability and Accountability Act of 1996, or HIPAA, Congress required the Department of Health and Human Services to issue a series of regulations establishing standards for the electronic
transmission of certain health information. Among these regulations were standards for the privacy of individually identifiable health information. Most health care providers were required to comply
with the Privacy Rule as of April 14, 2003.

HIPAA
does not preempt, or override, state privacy laws that provide even more protection for individuals' health information. These laws' requirements could further complicate our
ability to obtain necessary research data from our collaborators. In addition, certain state privacy and genetic testing laws may directly regulate our research activities, affecting the manner in
which we use and disclose individuals' health information, potentially increasing our cost of doing business, and exposing us to liability claims. In addition, patients and research collaborators may
have contractual rights that further limit our ability to use and disclose individually identifiable health information. Claims that we have violated individuals' privacy rights or breached our
contractual obligations, even if we are not found liable, could be expensive and time-consuming to defend and could result in adverse publicity that could harm our business.

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Other Regulations

In addition to privacy law requirements and regulations enforced by the FDA, we also are subject to various local, state and federal laws and regulations relating
to safe working conditions, laboratory and manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances, including chemicals,
micro-organisms and various radioactive compounds used in connection with our research and development activities. These laws include, but are not limited to, the Occupational Safety and Health Act,
the Toxic Test Substances Control Act and the Resource Conservation and Recovery Act. Although we believe that our safety procedures for handling and disposing of these materials comply with the
standards prescribed by state and federal regulations, we cannot assure you that accidental contamination or injury to employees and third parties from these materials will not occur. We may not have
adequate insurance to cover claims arising from our use and disposal of these hazardous substances.

Foreign Regulation

We will most likely have to obtain approval for the manufacturing and marketing of each of our products from regulatory authorities in foreign countries prior to
the commencement of marketing of the product in those countries. The approval procedure varies among countries, may involve additional preclinical testing and clinical trials, and the time required
may differ from that required for FDA approval or licensure. Although there is now a centralized European Union approval mechanism in place, this applies only to certain specific medicinal product
categories. In respect of all other medicinal products, each European country may impose certain of its own procedures and requirements in addition to those requirements set out in the appropriate
legislation, many of which could be time-consuming and expensive. Although data requirements presently exist for gene therapy and somatic cell therapy medicinal products, additional
European approval standards for cellular therapy are still under development, and consequently approval of cell therapy products in Europe may require additional data that we may not be able to
satisfy.

Employees

As of December 31, 2007, our headcount was 133 individuals, comprising 107 full-time employees and 26 full-time contract employees.
Of this total, 70 were engaged in manufacturing and operations, 46 were engaged in research and development and clinical trials and 17 were engaged in administration, facilities and finance. All of
our employees have entered into non-disclosure agreements with us regarding our intellectual property, trade secrets and other confidential information. None of our employees are
represented by a labor union or covered under a collective bargaining agreement, nor have we experienced any work stoppages.

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Executive Officers of the Registrant

Executive officers are appointed annually by the Board of Directors and, subject to the terms of any applicable employment agreement, serve at the discretion of
the Board of Directors. Information regarding our executive officers is as follows:

|Name                            |  | Age |  | Position                                                                      |  | Other Offices or Positions Held During the Past Five Years                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------------------- |  | --- |  | ----------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|C. Randal Mills, Ph.D.          |  | 36  |  | President and Chief Executive Officer (since July 2004)                       |  | Dr. Mills is also a member of the Board of Directors. Prior to joining Osiris, Dr. Mills was an executive officer of Regeneration Technologies, Inc. (NASDAQRTIX). Dr. Mills served
in several leadership positions at RTI from its formation in 1998 until 2004, including Vice President of Business Development and Vice President of Operation and R&D and is credited with several key initiatives including the development and
commercialization of RTI's core technology, BioCleanse®.                                 
|Philip R. Jacoby, Jr.           |  | 55  |  | Interim Chief Financial Officer and Corporate Secretary (since November 2007) |  | Mr. Jacoby has over 30 years of financial and management experience with public and privately held companies. Mr. Jacoby joined Osiris in April 2005 as our Corporate Controller and principal
accounting officer in preparation for our initial public offering. Prior to joining Osiris, Mr. Jacoby was the Vice President and Corporate Controller for FTI Consulting, Inc. (NYSEFCN) from 1999 through the first quarter of
2005.                                                                                          
|Harry E. Carmitchel             |  | 57  |  | Chief Operating Officer (since September 2004)                                |  | Mr. Carmitchel has over 25 years of general management and operations experience in the medical field. Prior to joining Osiris, Mr. Carmitchel was a Principal with the Pacific Consulting
Group for four years, where he specialized in corporate turnarounds. Prior to this time, Mr. Carmitchel was a General Manager with McQuay International, running a $410 million group, and spent eight years as President of the Medical
Division for Stryker Corporation.                                                           
|Michelle LeRoux Williams, Ph.D. |  | 33  |  | Vice President of
Development (since
May 2007)                                |  | Dr. Williams joined Osiris in 2001 as the Director of Orthopedics and was responsible for the development of Osteocel from the initial concept through product launch in 2005. Dr. Williams also
advanced the Chondrogen program from preclinical testing through the Phase I/II clinical trial. Prior to joining Osiris, Dr. Williams completed an NIH postdoctoral fellowship in tissue engineering at Columbia University, evaluating cellular
constructs for the repair and regeneration of cartilage in arthritis patients.

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|Earl R. Fender           |  | 60 |  | Vice President and General Manager of Orthopedics (since June 2006)         |  | Prior to joining Osiris, Mr. Fender served for over ten years with DePuy Spine, a Johnson & Johnson company, holding positions as Vice President, Sales, U.S. President, and finally as
Worldwide President. Under his direction, DePuy Spine became the second largest spinal implant manufacturer in the world.                                                                                                          
|------------------------ |  | -- |  | --------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Lode Debrabandere, Ph.D. |  | 43 |  | Vice President and General Manager, Inflammatory Diseases (since July 2006) |  | Prior to joining Osiris, Dr. Debrabandere served for over four years with Bristol-Myers Squibb as Vice President for Strategic Marketing for Neuroscience and Infectious Diseases. He led the
Neuroscience Unit and was the Global Brand Leader for Abilify. Previously, Dr. Debrabandere led the Marketing department of UCB Pharma Inc., focusing in the areas of allergy/respiratory (Zyrtec) and neurology
(Keppra).

Available Information

Our website address iswww.osiris.com. Our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange
Act of 1934 are available on our website free of charge as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange
Commission, or SEC. The public may read and copy these materials at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains such reports, proxy and information
statements and other information, and the Internet address ishttp://www.sec.gov. Information contained on our website is not and should not be deemed a
part of this annual report or any other report or filing filed with the SEC.

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Item 1A.    Risk Factors.

Risks Related To Our Business

We have a history of operating losses and may not achieve or sustain profitability.

We have incurred losses in each year since our inception and expect to experience losses over the next several years. As of December 31, 2007, we had an
accumulated deficit of $241.4 million. These losses resulted principally from costs incurred in our research and development programs and from our general and administrative expenses. These
losses, among other things, have had and will continue to have an adverse effect on our stockholders' equity, total assets and working capital.

We
expect to continue to incur significant operating expenses and anticipate that our expenses and losses will increase in the foreseeable future as we seek to:



In
addition, Osteocel is our only commercially available product. While revenue from Osteocel has increased since its commercial introduction in July 2005, our ability to scale up our
production capabilities for commercial quantities of this product are limited, and our costs in marketing and distributing this product will also increase as production increases.

The
extent of our future operating losses or profits is highly uncertain, and we may not achieve or sustain profitability. If we are unable to achieve and then maintain profitability,
the market value of our common stock will decline and you could lose part or all of your investment.

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If we are not able to recruit and retain qualified management and scientific personnel, we may fail in developing our technologies and biologic drug candidates.

Our future success depends to a significant extent on the skills, experience and efforts of the principal members of our scientific, management and sales
personnel. These members include C. Randal Mills, Ph.D., Harry E. Carmitchel, Michelle L. Williams, Ph.D., Philip R. Jacoby, Jr., Earl R. Fender and Lode Debrabandere Ph.D. The loss of any or all of
these individuals could harm our business and might significantly delay or prevent the achievement of research, development or business objectives. We have entered into employment agreements with
Dr. Mills, Messrs. Carmitchel, Fender and Dr. Debrabandere. The existence of an employment agreement does not, however, guarantee retention of these employees, and we may not be
able to retain those individuals for the duration of or beyond the end of their respective terms. Except for Dr. Mills, Messrs. Carmitchel, Fender and Dr. Debrabandere, none of
our employees is employed for a specified term. Competition for personnel is intense. We may be unable to retain our current personnel or attract or integrate other qualified management and scientific
personnel in the future.

We may not be able to raise additional capital necessary to fund our operations.

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



As
a result of these factors, we may need or choose to seek additional funding prior to our becoming cash flow positive on an operational basis. We would likely seek such funding through
public or private financings or some combination of them. We might also seek funding through collaborative arrangements if determined to be necessary or appropriate. Additional funding may not be
available to us on acceptable terms, or at all. If we obtain capital through collaborative arrangements, these arrangements could require us to relinquish rights to our technologies or biologic drug
candidates. If we raise additional capital through the incurrence of debt, we would likely become subject to covenants restricting our business activities, and holders of debt instruments would have
rights and privileges senior to those of our equity investors. In addition, servicing the interest and repayment obligations
under these borrowings would divert funds that would otherwise be available to support research and development, clinical or commercialization activities.

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If
we are unable to obtain adequate financing on a timely basis, we may be required to delay, reduce the scope of or eliminate one or more of our programs, any of which could have a
material adverse effect on our business, financial condition and results of operations.

If the potential of our stem cell therapies to treat diseases is not realized, the value of our technology and our development programs could be significantly reduced.

The potential of our stem cell therapies to treat diseases is currently being explored by us. We have not proven in clinical trials that our stem cell therapy
will be a safe and effective treatment for any disease. Our stem cell therapies are susceptible to various risks, including undesirable and unintended side effects, unintended immune system responses,
inadequate therapeutic efficacy or other characteristics that may prevent or limit their marketing approval or commercial use. We have not treated a sufficient number of patients to allow us to make a
determination that serious unintended consequences will not occur. If the potential of our stem cell therapies to treat disease is not realized, the value of our technology and our development
programs could be significantly reduced. Because our biologic drug candidates are based on MSCs, any negative developments regarding the therapeutic potential or side effects of MSCs could have a
material adverse effect on our business, financial condition and results of operations.

Our product development programs are based on novel technologies and are inherently risky.

We are subject to the risks of failure inherent in the development of products based on new technologies. The novel nature of our therapeutics creates significant
challenges in regards to product development and optimization, manufacturing, government regulation, third-party reimbursement and market acceptance. For example, the FDA has relatively limited
experience with stem cell therapies. None has been approved by the FDA for commercial sale, and the pathway to regulatory approval for our biologic drug candidates may accordingly be more complex and
lengthy. Additionally, stem cells are subject to donor-to-donor variability, which can make standardization more difficult. As a result, the development and commercialization
pathway for our therapies may be subject to increased uncertainty, as compared to the pathway for new conventional drugs.

There are no FDA approved treatments for some of the disease indications we are pursuing. This could complicate and delay FDA approval of our biologic drug candidates.

There are no drugs or therapies currently approved with stated indications for the first-line treatment of acute GvHD or the treatment of steroid
refractory GvHD. As a result, the clinical efficacy endpoints, or the criteria to measure the intended results of treatment, for our biologic drug candidate Prochymal for the treatment of GvHD may be
difficult to determine. In addition, patients battling GvHD and who, therefore, are candidates for treatment with Prochymal, are typically very ill as a result of an underlying genetic or oncologic
condition. Due to the graveness of their underlying disease and the very serious complications and disorders that often accompany acute GvHD, many of these patients will die from causes other than
GvHD prior to the completion of the study even if their GvHD responds favorably to treatment with Prochymal. The resulting reduction in the number of patients available for evaluation at the end of
the study may make it more difficult for us to demonstrate efficacy, as necessary to obtain FDA approval to market Prochymal for commercial sale.

There
are also no drugs or therapies currently approved with stated indications for the regeneration of meniscal tissue or the repair of heart muscle following heart attack. As a result,
the clinical endpoints for our biologic drug candidates Prochymal and Chondrogen may be difficult to determine. In the case of Prochymal for the treatment of Crohn's disease, there are other products
approved for the treatment of this disease, so it is expected that the clinical efficacy endpoints for Prochymal for this indication will be established by comparison with these already approved
treatments. In order to obtain FDA approval for this indication, we will have to demonstrate, among other things,

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that
our biologic drug candidate is safe and effective. The results of our clinical trials must be statistically significant, meaning that there must be sufficient data to indicate that it is unlikely
the outcome occurred by chance. These challenges may prevent us from developing and commercializing products on a timely or profitable basis, or at all.

Our biologic drug candidates represent new classes of therapy that the marketplace may not understand or accept.

Even if we successfully develop and obtain regulatory approval for our biologic drug candidates, the market may not understand or accept them. We are developing
biologic drug candidates that represent novel treatments and will compete with a number of more conventional products and therapies manufactured and marketed by others, including major pharmaceutical
companies. The degree of market acceptance of any of our developed and potential products will depend on a number of factors, including:



If
the health care community does not accept Osteocel or our potential products for any of the foregoing reasons, or for any other reason, it could affect our sales, having a material
adverse effect on our business, financial condition and results of operations.

The successful commercialization of our biologic drug candidates, or any of our other potential stem cell therapeutics, will depend on obtaining reimbursement from third-party
payors.

If we successfully develop and obtain necessary regulatory approvals, we intend to sell our biologic drug candidates initially in the United States and Europe. In
the United States, the market for any pharmaceutical product is affected by the availability of reimbursement from third-party payors, such as government health administration authorities, private
health insurers, health maintenance organizations and pharmacy benefit management companies. Stem cell therapies like Prochymal, and Chondrogen may be expensive compared with standard pharmaceuticals,
due to the higher cost and complexity associated with the research, development and production of stem cell therapies, the small size and large geographic diversity of the target patient population
for some indications, and the complexity associated with distribution of stem cell therapies which require special handling and shipment procedures and protocols. This, in turn, may make it more
difficult for us to obtain adequate reimbursement from third-party payors, particularly if we cannot demonstrate a favorable cost-benefit relationship. Third-party payors may also deny
coverage or offer inadequate levels of reimbursement

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for
our potential products if they determine that the product has not received appropriate clearances from the FDA or other government regulators or is experimental, unnecessary or inappropriate. For
example, patients battling GvHD and who, therefore, are candidates for treatment with Prochymal, are typically very ill as a result of an underlying genetic or oncologic condition. Because these
patients have a low probability of survival (whether or not their GvHD is successfully treated), third-party payors may resist reimbursing the cost of treatment.

In
the countries of Europe and in some other countries, the pricing of prescription pharmaceutical products and services and the level of government reimbursement are subject to
governmental control. In these countries, pricing negotiations with governmental authorities can take six to twelve months or longer after the receipt of marketing approval for a product. To obtain
reimbursement or pricing approval in some countries, we may be required to conduct one or more clinical trials that compares the cost effectiveness of our biologic drug candidates or products to other
available therapies. Conducting one or more clinical trials would be expensive and result in delays in commercialization of our products.

Managing
and reducing health care costs has been a general concern of federal and state governments in the United States and of foreign governments. Although we do not believe that any
recently enacted or presently proposed legislation should impact our business, we might be subject to future regulations or other cost-control initiatives that materially restrict the
price we receive for our products. In addition, third-party payors are increasingly challenging the price and cost-effectiveness of medical products and services, and many limit
reimbursement for newly approved health care products. In particular, third-party payors may limit the indications for which they will reimburse patients who use any products that we may develop. Cost
control initiatives could decrease the price for products that we may develop, which would result in lower product revenues to us.

Our dependence upon a limited supply of adult marrow-rich bone necessary to produce Osteocel may impact our ability to produce Osteocel on a large scale.

The production of Osteocel does not involve an expansion of MSCs and is therefore limited by the amount of adult human marrow-rich bone donations that
are available to us. Since the introduction of Osteocel into the marketplace in July 2005, we have been unable to obtain quantities of adult human marrow-rich bone sufficient to meet the
demand for Osteocel. Osteocel consists of primary, or unexpanded, MSCs in a matrix of viable cancellous bone. Cancellous bone is the porous and spongy inner structure of bones accounting for
approximately 20% of total bone mass. The bone and cells are derived from human organ and tissue donors. We rely on the efforts of not-for-profit donor procurement agencies to
educate the public and foster an increased willingness to donate bone tissue. These organizations may not be able to provide us with sufficient amounts of viable cancellous bone to meet present or
future demand for Osteocel. Our inability to secure enough viable cancellous bone to meet our Osteocel demands could limit our ability to successfully market and drive market acceptance of Osteocel
and may limit our potential revenues from Osteocel.

Our dependence upon a limited supply of bone marrow donors may impact our ability to produce sufficient quantities of our biologic drug candidates as necessary to complete our
clinical trials, and if our trials are successful, to meet product demand.

The population of acceptable bone marrow donors is limited to volunteers between the ages of 18 and 30. In addition, potential donors are prescreened for a
variety of health conditions and are only allowed to donate bone marrow a total of six times in their lifetime, further limiting the total number of potential donors. The amount of bone marrow donated
may be insufficient for us to mass produce our biologic drug candidates. Future government regulation or health concerns may also reduce the number of donors or otherwise limit the amount of bone
marrow available to us. If we cannot secure quantities of bone marrow sufficient to meet the manufacturing demands for our clinical trials, we

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might
not be able to complete our clinical trials and obtain marketing approval for our biologic drug candidates. Moreover, even if our clinical trials are successful and we obtain marketing approval
for our biologic drug candidates, our inability to secure enough bone marrow to meet product demand would limit our potential revenues.

Osteocel and our biologic drug candidates are derived from human tissue and bone marrow sources and therefore have the potential for disease transmission.

The utilization of donated adult human cancellous bone and bone marrow creates the potential for transmission of communicable disease, including but not limited
to human immunodeficiency virus, or HIV, viral hepatitis, syphilis, Creutzfeldt-Jakob disease, or the human form of "mad cow" disease, and other viral, fungal or bacterial pathogens. Although we are
required to comply with federal and state regulations intended to prevent communicable disease transmission, and our suppliers of adult human bone and bone marrow are also required to comply with such
regulations in connection with their collection, storage and supply to us:



Any
actual or alleged transmission of communicable disease could result in patient claims, litigation, distraction of management's attention and potentially increased expenses. Further,
any failure in screening, whether by us or other manufacturers of similar products, could adversely affect our reputation, the support we receive from the medical community and overall demand for our
products. As a result, such actions or claims, whether or not directed at us, could have a material adverse effect on our reputation with our customers and our ability to market our products, which
could have a material adverse effect on our business, financial condition and results of operations.

We may not be able to manufacture Osteocel in quantities sufficient to expand our market for the product and may not be able to manufacture our biologic drug candidates in
quantities sufficient for later stage clinical studies or for commercial sale.

We may encounter difficulties in the production of Osteocel and our biologic drug candidates due to our manufacturing capabilities. This difficulty could reduce
sales of our products, increase our costs or cause production delays, any of which could damage our reputation and hurt our profitability. Even if
we were to obtain access to quantities of adult marrow-rich bone sufficient to allow us otherwise to expand our Osteocel manufacturing capabilities, we may not be able to produce
sufficient quantities of the product at an acceptable cost, or at all.

If
we successfully obtain marketing approval for one of our biologic drug candidates, we may not be able to produce sufficient quantities of the product at an acceptable cost.
Commercial-scale production of therapies made from live human mesenchymal stem cells involves production in small batches and strict adherence to complex manufacturing and storage protocols and
procedures. Our biologic drug candidates are inherently more difficult to manufacture at commercial-scale than chemical pharmaceuticals, which are manufactured using precise chemical formulations and
operational methods.

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We use third-party collaborators to help us develop and commercialize our products, and our ability to commercialize such products may be impaired or delayed if collaborations
are unsuccessful.

We have arrangements in place with third-party collaborators as a means to help us with research and development efforts or marketing and distribution. For
example:



We
may enter into additional collaborations in the future. We are dependent upon the success of our current and any future collaborators in performing their responsibilities and their
continued cooperation. Our collaborators may not cooperate with us or perform their obligations under our agreements with them. We cannot control the amount and timing of our collaborators' resources
that will be devoted to performing their responsibilities under our agreements with them. Our collaborators may choose to pursue alternative technologies in preference to those being developed in
collaboration with us. The development and commercialization of our potential products will be delayed if collaborators fail to conduct their responsibilities in a timely manner or if they breach or
terminate their collaboration agreements with us. Disputes with our collaborators could result in product development delays, decreased revenues and litigation expenses. In addition, because our
products may be marketed under a different brand name by our collaborators, as is the case in our relationship with Blackstone, should the relationship be terminated for any reason, our product
recognition could be adversely impacted, affecting our product and potentially causing brand confusion in the market.

We are dependent upon third-party suppliers for services and raw materials needed for the manufacture, and we are dependent upon third parties for the distribution, of Osteocel
and our biologic drug candidates. If any of these third parties fail or are unable to perform in a timely manner, our ability to manufacture and deliver will be compromised.

In order to produce our biologic drug candidates for use in clinical studies, and to produce Osteocel and any other of our biologic drug candidates that may be
approved for commercial sale, we require biological media, reagents and other highly specialized materials. This is in addition to the adult marrow-rich bone donations used in the
manufacture of Osteocel, and the bone marrow aspirate used in the manufacture of our biologic drug candidates. These items must be manufactured and supplied to us in sufficient quantities and in
compliance with current Good Manufacturing Practices, or cGMP. To meet these requirements, we have entered into supply agreements with firms that manufacture these components to cGMP standards. Our
requirements for these items are expected to increase if and when we transition to the manufacture of commercial quantities of our biologic drug candidates.

In
addition, as we proceed with our clinical trial efforts, we must be able to demonstrate to the FDA that we can manufacture our biologic drug candidates with consistent
characteristics. Accordingly, we are materially dependent on these suppliers for supply of cGMP-grade components of consistent quality. Our ability to complete ongoing clinical trials may
be negatively affected in the event that we are forced to seek and validate a replacement source for any of these critical components. If we are not able to obtain adequate supplies of these items of
consistent quality from our third-party suppliers, it

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will
also be more difficult to manufacture commercial quantities of Osteocel or any of our current biologic drug candidates that may subsequently be approved for commercial sale.

In
addition, we rely on third parties to distribute Osteocel and, if approved, our biologic drug candidates. Proper shipping and distribution requires compliance with specific storage
and shipment procedures. For example, our products must be placed in a freezer within 72 hours of shipment. Failure to comply with these procedures or the occurrence of inadvertent damage to
the shipping container will necessitate return and replacement, potentially resulting in additional cost and causing us to fail to meet supply requirements.

Use of third-party manufacturers may increase the risk that we will not have adequate quantities of our biologic drug candidates.

We use third-party manufacturers to supply our biologic drug candidates for clinical trials. Reliance on third-party manufacturers entails risks to which we would
not be subject if we manufactured such components ourselves, including:



Our
contract manufacturers are subject to all of the risks and uncertainties that we have when we manufacture on our own. Similar to us, they are subject to ongoing, periodic,
unannounced inspection by the FDA and corresponding state and foreign agencies or their designees to ensure strict compliance with cGMP regulations and other governmental regulations and corresponding
foreign standards. However, we do not control compliance by our contract manufacturers with these regulations and standards. Our present or future manufacturers might not be able to comply with these
regulatory requirements. If our third-party manufacturers fail to comply with applicable regulations, the FDA or other regulatory authorities could impose sanctions on us, including fines,
injunctions, civil penalties, denial of marketing approval of our biologic drug candidates, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of biologic drug
candidates or our other products, operating restrictions and criminal prosecutions. Any of these actions could significantly and adversely affect supplies of our biologic drug candidates or other
products and could have a material adverse effect on our business, financial condition and results of operations.

We
have contracted with Lonza to manufacture quantities of our stem cell drug candidates for our clinical trials. If Lonza is unable to ramp up production sufficiently, we may also not
be able to meet anticipated market demand in the future.

If our processing and storage facility or our clinical manufacturing facilities are damaged or destroyed, our business and prospects would be negatively affected.

If our processing and storage facility or the equipment in the facility were to be significantly damaged or destroyed, we could suffer a loss of some or all of
the stored units of our biologic drug candidates and it would force us to halt our clinical trial processes.

We
have a manufacturing facility located in Baltimore, Maryland at which we produce and store Osteocel prior to sale. If this facility or the equipment in it is significantly damaged or
destroyed, we may not be able to quickly or inexpensively replace our manufacturing capacity. This facility is located on the Baltimore harbor, and in September 2003 it was flooded by Hurricane
Isabel. This event resulted in a temporary suspension of our manufacturing operations. In the event of another temporary or protracted loss of this facility or equipment, we may be able to transfer
manufacturing to a third

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party,
but the shift would likely be expensive, and the timing would depend on availability of third-party resources and the speed with which we could have a new facility comply with the necessary
regulatory requirements. Such an event could halt our distribution of Osteocel due to a lack of available product.

We
lease approximately 61,203 square feet of space in Columbia, Maryland, and plan to begin manufacturing Osteocel in Columbia during the second quarter of 2008. We intend to move all
our manufacturing and storage from Baltimore to Columbia during the third quarter of 2008.

Currently,
we maintain insurance coverage totaling $19.4 million against damage to our property and equipment, an additional $4.0 million to cover business interruption and
extra expenses, and $5.6 million to cover R&D restoration expenses. If we have underestimated our insurance needs, we will not have sufficient insurance to cover losses above and beyond the
limits on our policies.

Ethical and other concerns surrounding the use of stem cell therapy or human tissue may negatively affect public perception of us or our products or biologic drug candidates,
or may negatively affect regulatory approval of our products or biologic drug candidates, thereby reducing demand for our products and adversely affecting the market price for our common stock.

The commercial success of Osteocel and our biologic drug candidates will depend in part on general public acceptance of the use of stem cell therapy and donated
human tissue for the prevention or treatment of human diseases. The use of embryonic stem cells and fetal tissue for research and stem cell therapy has been the subject of substantial national and
international debate regarding related ethical, legal and social issues. In the U.S., for example, federal government funding of embryonic stem cell research has been limited to specifically
identified cell lines and is not otherwise available. We do not use embryonic stem cells or fetal tissue, but the public may not be able to, or may fail to, differentiate our use of adult stem cells
from the use by others of embryonic stem cells or fetal tissue. This could result in a negative perception of our company or our products or biologic drug candidates.

We
obtain our stem cells from volunteer adult bone marrow donors and we obtain cancellous human bone for the production of Osteocel from non-profit organizations that collect
and process human organ and tissue donations. Bone marrow donors receive payment, but payment is not received by either human organ and tissue donors or their surviving family members. Ethical
concerns have been raised by some about the use of donated human tissue in a for-profit setting, as we are doing.

Future
adverse events in the field of stem cell therapy or changes in public policy could also result in greater governmental regulation of our products and biologic drug candidates and
potential regulatory delays relating to the testing or approval of our biologic drug candidates.

We compete with other companies for funding and product sales. Many of our competitors have greater resources or capabilities than we have, or may already have or succeed in
developing better products or in developing products more quickly than we do, and we may not compete successfully with them.

The pharmaceutical and biotechnology industries are highly competitive. We compete for funding and, if our products become available for commercial sale, we will
compete in the market place. For funding, we compete primarily with other companies which, like us, are focused on developing novel products or therapies for the treatment of human disease based on
stem cells or other novel scientific principles. These include Aastrom Biosciences, Advanced Cell Technology, Athersys, Cellerant Therapeutics, Cognate Therapeutics, Cytori Therapeutics, Gamida Cell,
Geron, Mesoblast, MultiCell Technologies, Neuronyx, Theradigm, ViaCell, and StemCells.

In
the marketplace, we compete or may eventually compete with other companies and organizations that are marketing or developing therapies for our targeted disease indications, based on
traditional pharmaceutical, medical device or other, non-cellular therapy and technologies. These

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include:
Johnson & Johnson, the manufacturer of CELLECT for the repair of bone, which competes with Osteocel; Medtronic and Stryker, the manufacturers of InFuse and
OP-1, respectively, which compete with Osteocel; Novartis, the manufacturer of Neoral® for the prevention of organ rejection in transplant patients, which would compete with
Prochymal for the treatment of GvHD; and Johnson & Johnson, the manufacturer of Remicade®, and Abbott, the manufacturer of Humira, which would compete with Prochymal for the
treatment of Crohn's disease. In addition to those listed above, we have other potential competitors developing a variety of therapeutics.

We
also face competition in the cell therapy field from academic institutions and governmental agencies. Many of our current and potential competitors have greater financial and human
resources than we have, including more experience in research and development and more established sales, marketing and distribution capabilities.

We
anticipate that competition in our industry will increase. In addition, the health care industry is characterized by rapid technological change, resulting in new product introductions
and other technological advancements. Our competitors may develop and market products that render our current product or any future product non-competitive or otherwise obsolete.

The use of our stem cell therapies in human subjects may expose us to product liability claims, and we may not be able to obtain adequate insurance.

We face an inherent risk of product liability claims. Neither Osteocel nor any of our biologic drug candidates has been widely used over an extended period of
time, and therefore our safety data are limited. We derive the raw materials for manufacturing Osteocel and our biologic drug candidates from human donor sources, the manufacturing process is complex,
and the handling requirements are specific, all of which increase the likelihood of quality failures and subsequent product liability claims. We will need to increase our insurance coverage if and
when we begin commercializing our biologic drug candidates. We may not be able to obtain or maintain product liability insurance on acceptable terms with adequate coverage or at all. If we are unable
to obtain insurance, or if claims against us substantially exceed our coverage, then our business could be adversely impacted. Whether or not we are ultimately successful in any product liability
litigation, such litigation could consume substantial amounts of our financial and managerial resources and could result in:



Any
of these results could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Intellectual Property

If our patent position does not adequately protect Osteocel®, our biologic drug candidates or any future products, others could compete against us more directly,
which would harm our business and have a material adverse effect on our financial condition and results of operations.

Our success depends, in large part, on our ability to obtain and maintain intellectual property protection for our biologic drug candidates. The patent position
of biotechnology companies is generally highly uncertain, involves complex legal and factual questions and has been the subject of

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much
litigation. Neither the U.S. Patent and Trademark Office nor the courts has a consistent policy regarding the breadth of claims allowed or the degree of protection afforded under many
biotechnology patents.

The
claims of our existing U.S. patents and those that may issue in the future, or those licensed to us, may not confer on us significant commercial protection against competing
products. Third parties may challenge, narrow, invalidate or circumvent any patents we own or may obtain in the future. Our patents on MSC technology, in particular, are quite broad in that they cover
mesenchymal stem cells and the therapeutic use thereof. Patents with broad claims tend to be more vulnerable to challenge by other parties than patents with more narrowly written claims. Also, our
pending patent applications may not issue, and we may not receive any additional patents. Further, the laws of foreign countries may not protect our intellectual property rights to the same extent as
do the laws of the United States. Our patents might not contain claims that are sufficiently broad to prevent others from utilizing our technologies.

Consequently,
our competitors may independently develop competing products that do not infringe our patents or other intellectual property. We have nine granted patents and have filed
six patent applications that correspond or are related to our commercially available product, Osteocel. The six patent applications have not yet issued and there can be no assurances that they will
ever issue. Osteocel is different from our other biologic drug candidates in that it contains primary, or unexpanded, MSCs in a matrix of cancellous bone. Because FDA approval is generally not
required for tissue based products like Osteocel, competitors might choose to enter this market and produce a substantially similar product whereby we may not be able to prevent the marketing and sale
of any such similar products by others. Should others produce a substantially similar product, we will be subject to increased competition and our potential revenues from Osteocel sales may be
limited.

Because
of the extensive time required for development, testing and regulatory review of a potential product, it is possible that, before any of our products can be commercialized, any
related patent may expire or remain in force for only a short period following commercialization, thereby reducing any advantages of the patent. For instance, one of our base patents on MSC technology
will expire in 2013. To the extent our biologic drug candidates based on that technology are not commercialized significantly ahead of this date, or to the extent we have no other patent protection on
such products, those products would not be protected by patents beyond 2013. The background technologies used in
the development of our biologic drug candidates are known in the scientific community, and it is possible to duplicate the methods we use to create our biologic drug candidates.

If we are unable to protect the confidentiality of our proprietary information and know-how, our competitive position would be impaired and our business, financial
condition and results of operations could be adversely affected.

A significant amount of our technology, especially regarding manufacturing processes, is unpatented and is maintained by us as trade secrets. In an effort to
protect these trade secrets, we require our employees, consultants, collaborators and advisors to execute confidentiality agreements upon the commencement of their relationships with us. These
agreements require that all confidential information developed by the individual or made known to the individual by us during the course of the individual's relationship with us be kept confidential
and not disclosed to third parties. These agreements, however, may not provide us with adequate protection against improper use or disclosure of confidential information, and these agreements may be
breached. For example, a portion of the manufacture of Osteocel is protected by trade secrets. A breach of confidentiality could affect our competitive position. In addition, in some situations, these
agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants, collaborators or advisors have previous employment or consulting relationships. Also,
others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets.

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Adequate
remedies may not exist in the event of unauthorized use or disclosure of our confidential information. The disclosure of our trade secrets would impair our competitive position
and could have a material adverse effect on our business, financial condition and results of operations.

If we infringe or are alleged to infringe intellectual property rights of third parties, it will adversely affect our business, financial condition and results of operations.

Our research, development and commercialization activities, including any biologic drug candidates or products resulting from these activities, may infringe or be
claimed to infringe patents owned by third parties and to which we do not hold licenses or other rights. There may be applications that have been filed but not published that, when issued, could be
asserted against us. These third parties could bring claims against us that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages.
Further, if a patent infringement suit were brought against us, we could be forced to stop or delay research, development, manufacturing or sales of the product or biologic drug candidate that is the
subject of the suit.

As
a result of patent infringement claims, or in order to avoid potential claims, we may choose or be required to seek a license from the third party. These licenses may not be available
on acceptable terms, or at all. Even if we are able to obtain a license, the license would likely obligate us to pay license fees or royalties or both, and the rights granted to us might be
nonexclusive, which could result in our competitors gaining access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some
aspect of our business operations, if, as a result of actual or threatened patent infringement claims, we are unable to enter into licenses on acceptable terms. All of the issues described above could
also impact our collaborators, which would also impact the success of the collaboration and therefore us.

There
has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the pharmaceutical and biotechnology industries. In addition to
infringement claims against us, we may become a party to other patent litigation and other proceedings, including interference proceedings declared by the United States Patent and Trademark Office and
opposition proceedings in the European Patent Office, regarding intellectual property rights with respect to our products and technology. For example, the patent that was granted to us in Europe for
human mesenchymal stem cells has been opposed in the European Patent Office by two different companies. The outcome of the proceedings is uncertain at this time, but we are vigorously pursuing our
rights. The cost to us of any patent litigation or other proceeding, even if resolved in our favor, could be substantial. Some of our competitors may be able to sustain the costs of such litigation or
proceedings more effectively than we can because of their substantially greater financial resources. Patent litigation and other proceedings may also absorb significant management time. Uncertainties
resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace and, as a result, on our
business, financial condition and results of operations.

We may become involved in lawsuits to protect or enforce our patents or the patents of our collaborators or licensors, which could be expensive and time consuming.

Competitors may infringe our patents or the patents of our collaborators or licensors. As a result, we may be required to file infringement claims to counter
infringement or unauthorized use. This can be expensive, particularly for a company of our size, and time-consuming. In addition, in an infringement proceeding, a court may decide that a
patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover its technology. An adverse
determination of any litigation or defense proceedings could put one or more of our patents at risk of being invalidated or interpreted narrowly and could put our patent applications at risk of not
issuing. We are aware of several companies that are employing mesenchymal stem cell technology in their research and product development efforts. If such companies commercialize such products, there
is no assurance that we would have a basis for initiating patent infringement proceedings or that if initiated we would prevail in such proceedings.

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Interference proceedings brought by the U.S. Patent and Trademark Office may be necessary to determine the priority of inventions with respect to our patent applications or those of our
collaborators or licensors. Litigation or interference proceedings may fail and, even if successful, may result in substantial costs and distraction to our management. We may not be able, alone or
with our collaborators and licensors, to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the United States.

Furthermore,
because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could
be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other
interim proceedings or developments. If investors perceive these results to be negative, the market price for our common stock could be significantly harmed.

Risks Related to Regulatory Approval and Other Government Regulations

If we are not able to successfully develop and commercialize our biologic drug candidates and obtain the necessary regulatory approvals, we may not generate sufficient revenues
to continue our business operations.

In order to generate sales revenue from our biologic drug candidates, we must conduct extensive preclinical studies and clinical trials to demonstrate that our
biologic drug candidates are safe and effective and obtain required regulatory approvals. Our early stage biologic drug candidates may fail to perform as we expect. Moreover, our biologic drug
candidates in later stages of development may fail to show the desired safety and efficacy traits despite having progressed successfully through preclinical or initial clinical testing. We will need
to devote significant additional research and development, financial resources and personnel to develop commercially viable products and obtain the necessary regulatory approvals.

If
our biologic drug candidates do not prove to be safe and efficacious in clinical trials, we will not obtain the required regulatory approvals. If we fail to obtain such approvals, we
may not generate sufficient revenues to continue our business operations.

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.

We cannot market and sell our biologic drug candidates in the United States or in other countries if we fail to obtain the necessary regulatory approvals or licensure.

We cannot sell our biologic drug candidates until regulatory agencies grant marketing approval, or licensure. The process of obtaining regulatory approval is
lengthy, expensive and uncertain. It is likely to take two to three years or more to obtain the required regulatory approvals for our lead stem cell biologic drug candidate, Prochymal, or we may never
gain the necessary approvals. Any difficulties that we encounter in obtaining regulatory approval may have a substantial adverse impact on our operations and cause our stock price to decline
significantly. Moreover, because our biologic drug candidates are all based on a single platform technology, MSCs, any adverse events in our clinical trials for one of our biologic drug candidates
could negatively impact the clinical trials and approval process for our other biologic drug candidates.

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To
obtain marketing approvals in the United States for MSC products, for instance, we must, among other requirements, complete carefully controlled and well-designed clinical
trials sufficient to demonstrate to the FDA that the biologic drug candidate is safe and effective for each disease for which we seek approval. Several factors could prevent completion or cause
significant delay of these trials, including an inability to enroll the required number of patients or failure to demonstrate adequately that MSCs are safe, effective and potent for use in humans.
Negative or inconclusive results from or adverse medical events during a clinical trial could cause the clinical trial to be repeated or a program to be terminated, even if other studies or trials
relating to the program are successful. The FDA can place a clinical trial on hold if, among other reasons, it finds that patients enrolled in the trial are or would be exposed to an unreasonable and
significant risk of illness or injury. If safety concerns develop, we or the FDA could stop our trials before completion. Some participants in our MSC clinical trial have experienced serious adverse
events, four of which have been determined to be possibly related to MSCs and one of which has been determined to be probably related. A serious adverse
event is an event that results in significant medical consequences, such as hospitalization, disability or death, and must be reported to the FDA. We cannot assure you that safety concerns regarding
MSCs will not develop.

The
pathway to regulatory approval for MSCs may be more complex and lengthy than for approval of a new conventional drug. Similarly, to obtain approval to market our stem cell products
outside of the United States, we will need to submit clinical data concerning our products and receive regulatory approval from governmental agencies, which in certain countries includes approval of
the price we intend to charge for our product. We may encounter delays or rejections if changes occur in regulatory agency policies during the period in which we develop a biologic drug candidate or
during the period required for review of any application for regulatory agency approval. If we are not able to obtain regulatory approvals for use of our biologic drug candidates under development, we
will not be able to commercialize such products, and therefore may not be able to generate sufficient revenues to support our business.

If we are not able to conduct our clinical trials properly and on schedule, marketing approval by FDA and other regulatory authorities may be delayed or denied.

The completion of our clinical trials may be delayed or terminated for many reasons, including, but not limited to, if:



Our
development costs will increase if we have material delays in our clinical trials, or if we are required to modify, suspend, terminate or repeat a clinical trial. If we are unable to
conduct our clinical trials properly and on schedule, marketing approval may be delayed or denied by the FDA.

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We may not be able to secure and maintain research institutions to conduct our clinical trials.

We rely on research institutions to conduct our clinical trials. Specifically, the limited number of bone marrow transplant centers further heightens our
dependence on such research institutions for the Phase III Prochymal trials. Our reliance upon research institutions, including hospitals and clinics, provides us with less control over the
timing and cost of clinical trials and the ability to recruit subjects. If we are unable to reach agreement with suitable research institutions on acceptable terms, or if any resulting agreement is
terminated, we may be unable to quickly replace the research institution with another qualified institution on acceptable terms. We may not be able to secure and maintain suitable research
institutions to conduct our clinical trials.

Final marketing approval of our biologic drug candidates by the FDA or other regulatory authorities for commercial use may be delayed, limited, or denied, any of which would
adversely affect our ability to generate operating revenues.

Any of the following factors may cause final marketing approval for our biologic drug candidates to be delayed, limited or denied:



If
marketing approval for our biologic drug candidates is delayed, limited or denied, our ability to market products, and our ability to generate product sales, would be adversely
affected.

Should the FDA decide that Osteocel does not meet the appropriate regulatory requirements, we will be required to stop production, which will have a material adverse effect on
our business, financial condition and results of operations.

The FDA has developed a tiered, risk-based regulatory framework, which includes criteria for facility management, quality assurance, donor selection,
and processing of human cells, tissues, and cellular and tissue based products. We believe that commercial sale of Osteocel does not require pre-market approval by the FDA because we
believe that it meets the regulatory definition of human cells, tissue, and cellular and tissue-based products, or HCT/Ps. However, should the FDA decide that Osteocel does not meet the regulatory
definition of HCT/Ps, we will not be able to produce and sell Osteocel until we obtain FDA approval, which could take years to obtain and which could have a material adverse effect on our business,
financial condition and results of operations.

Producing and marketing an approved drug or other medical product is subject to significant and costly post-approval regulation.

It is likely that Prochymal, if approved based on our currently contemplated Phase III trial, will receive conditional approval by the FDA, and we will be
required to conduct Phase IV clinical trials to obtain full approval. Even if we obtain full approval of a product, that approval is subject to limitations on the indicated uses for which we
can market it. After granting marketing approval, the FDA and

43

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regulatory
agencies in other countries continue to review and inspect marketed products, manufacturers and manufacturing facilities, creating 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 marketing approval of our products.

Our business involves the use of hazardous materials that could expose us to environmental and other liability.

We have facilities in Maryland that are subject to various local, state and federal laws and regulations relating to safe working conditions, laboratory and
manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances, including chemicals, micro-organisms and various radioactive
compounds used in connection with our research and development activities. In the United States, these laws include the Occupational Safety and Health Act, the Toxic Test Substances Control Act and
the Resource Conservation and Recovery Act. We cannot assure you that accidental contamination or injury to our employees and third parties from hazardous materials will not occur. We do not have
insurance to cover claims arising from our use and disposal of these hazardous substances other than limited clean-up expense coverage for environmental contamination due to an otherwise
insured peril, such as fire.

We may not be able to obtain or maintain Orphan Drug designation for our biologic drug candidates.

Some jurisdictions, including the European Union and the United States, may designate drugs for relatively small patient populations as orphan drugs. Although the
FDA and its European counterpart, EMEA have designated Prochymal for the treatment of steroid refractory GvHD as an orphan drug, none of our other biologic drug candidates have received such
designation. Orphan Drug designation does not convey any advantage in, or shorten the duration of, the regulatory review and approval process, but does make the product eligible for orphan drug
exclusivity, reduced filing fees and specific tax credits. Generally, if a company receives the first marketing approval for a product with an Orphan
Drug designation in the clinical indication for which it has such designation, the product is entitled to orphan drug exclusivity. Orphan drug exclusivity means that the health authorities will not
approve another application to market the same drug for the same indication, except in limited circumstances, for a period of up to seven years in the United States and ten years in Europe. This
exclusivity, however, could block the approval of our biologic drug candidates if a competitor obtains marketing approval before us. Even if we obtain orphan drug exclusivity for any of our biologic
drug candidates, we may not be able to maintain it. For example, if a competitive product is shown to be clinically superior to our product, any orphan drug exclusivity we have will not block the
approval of such competitive product.

The Fast Track designation for development of any of our products may not lead to a faster development or regulatory review or approval process, and it does not increase the
likelihood the biologic drug candidate will receive marketing approval.

If a drug is intended for the treatment of a serious or life-threatening condition and the drug demonstrates the potential to address unmet medical
needs for this condition, the drug sponsor may apply for FDA Fast Track designation for a particular indication. Marketing applications filed by sponsors of products in Fast Track development may
qualify for priority review under the policies and procedures offered by the FDA, but the Fast Track designation does not assure any such qualification. Although we have obtained a Fast Track
designation from the FDA for Prochymal for the treatment of GvHD and treatment refractory Crohn's disease, receipt of Fast Track designation may not result in a faster development process, review or
approval compared to drugs considered for approval under conventional FDA procedures. In addition, the FDA may withdraw our Fast Track designation at any

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time.
If we lose our Fast Track designation, the approval process may be delayed. In addition, our Fast Track designation does not guarantee that we will qualify for or be able to take advantage of
the expedited review procedures and does not increase the likelihood that Prochymal will receive regulatory approval for the treatments of steroid refractory GvHD or Crohn's disease.

Risks Related to Government Contracts

Federal government spending priority or our relationships with the federal government may change in a manner that harms our business or prospects.

Our ability to successfully pursue development and purchase agreements with United States and Allied governmental agencies for countermeasures to nuclear
terrorism and other radiological emergencies, including the contract awarded to us by the DoD for the development and stockpiling of Prochymal for the treatment of acute radiation syndrome ("ARS"),
depends upon continued federal government expenditures on defense, emergency preparadness and other programs. These expenditures will likely fluctuate over time. While spending authorizations for
defense and emergency preparadness related programs by the government have increased in recent years, and in particular after the 2001 terrorist attacks, future levels of expenditures and
authorizations for these programs may decrease, remain constant or shift to program areas inapplicable to us. Our business, prospects, financial condition and/or operating results could be materially
harmed by budgetary constraints affecting federal government spending generally, or specific departments or agencies in particular, and by changes in fiscal policies or available funding, or by
changes in federal government programs or requirements or delays in government appropriations process. In addition, our business, prospects, financial condition and/or operating results could be
materially harmed if we are suspended or disbarred from contracting with the federal government or a significant governmental agency, or our reputation or relationship with governmental entities is
impaired, or the government otherwise declines to do business with us, or significantly decreases the amount of business it is willing to do with us.

Federal government contracts contain provisions that may be unfavorable to us.

Federal government contracts contain provisions, and are subject to laws and regulations, that give the government rights and remedies not typically found in
commercial contracts. These provisions may allow the government to terminate existing contracts for convenience, as well as for default, to reduce or modify contracts or subcontracts, to cancel
multi-year contracts or related purchase orders if funds for contract performance for any subsequent year become unavailable, to decline to exercise an option to renew a
multi-year contract or to decline to purchase product pursuant to an option afforded under a contract. If the government terminates a contract for convenience, we may recover only our
incurred or committed costs, settlement expenses and profit on the work completed prior to the termination. If the government terminates a contract for default, we may not recover even those amounts,
and instead may be liable for excess costs incurred by the government in procuring undelivered items and services from another source.

Unfavorable federal government audit results could subject us to penalties or sanctions and could impair our ability to win new contracts.

The Defense Contract Audit Agency ("DCAA") and other government agencies routinely audit and investigate government contracts and systems. These agencies review a
contractor's performance on its contract, cost structure and compliance with applicable laws, regulations and standards. The DCAA also reviews the adequacy of, and a contractor's compliance with, its
internal control systems and policies, including the contractor's accounting, purchasing, property, estimating, compensation and managing information systems. Allegations of impropriety or deficient
controls could harm our reputation and/or adversely influence the award of new contracts. Any costs founds to be improperly allocated to a specific contract will not be reimbursed, while such costs
already reimbursed must be

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refunded.
Therefore, a DCAA audit could result in a substantial adjustment to our revenue earned from federal government contracts.

The government may terminate our federal government contracts at any time.

Federal government contracts may span one or more base years and one or more option years, and may provide the government with one or more options in respect of
continued performance by us thereunder. For example, our contract with the DoD for the development and stockpiling of Prochymal for the treatment of ARS provides the DoD with successive options for
the purchase of Prochymal, assuming receipt of FDA approval for its use in the treatment of ARS. Federal government agencies have no obligation to exercise these options unless determined to be in the
best interest of the government. Additionally, federal government contracts typically contain provisions permitting the government to terminate the contract for its convenience. A decision not to
exercise an option or a decision to terminate a contract could have a material adverse effect on our business and prospects.

If we fail to comply with complex procurement laws and regulations, we could incur various penalties or sanctions.

To the extent which we enter into contracts or other arrangements with the United States or other Allied governments, we must comply with the laws and regulations
relating to the formation, administration and performance of those contracts. These laws and regulations affect how we conduct business with our government contracts. In complying with these laws and
regulations, we may incur additional costs, and non-compliance may also allow for the assignment of additional fines and penalties, including contractual damages. Among these laws and
regulations are the Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of United States federal government contracts, the Truth in
Negotiations Act, which
requires certification and disclosure of all costs and pricing data in connection with contract negotiations, and laws, regulations and executive orders restricting the use and dissemination of
information classified for national security purposes, and restricting the export of certain products and technical data. We are subject to periodic review of our performance under and compliance with
the terms of any federal government contracts to which we are a party. As a result of these reviews, we may learn that we are not in compliance with all of the terms of any such contracts and we could
be subject to civil or criminal penalties or administrative sanctions for failure of compliance.

Risks Related to Our Common Stock

The trading price of the shares of our common stock is highly volatile, and purchasers of our common stock could incur substantial losses.

Our stock price is volatile. The stock market in general and the market for biotechnology companies in particular have experienced extreme volatility that has
often been unrelated to the operating performance of particular companies. As a result of this volatility, investors may not be able to sell their common stock at or above the price they paid for it.
The market price for our common stock may be influenced by many factors, including:



46

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In
addition, in the past, stockholders have initiated class action lawsuits against biotechnology and pharmaceutical companies following periods of volatility in the market prices of
these companies' stock. Such litigation, if instituted against us, could cause us to incur substantial costs and divert management's attention and resources, which could have a material adverse effect
on our business, financial condition and results of operations.

Concentration of ownership of our common stock among our existing executive officers, directors and principal stockholders may prevent new investors from influencing
significant corporate decisions.

Our executive officers, directors and beneficial owners of 5% or more of our common stock and their affiliates, in aggregate, beneficially own approximately 60%
of our outstanding common stock as of December 31, 2007. These persons, acting together, will be able to significantly influence all matters requiring stockholder approval, including the
election and removal of directors and any merger or other significant corporate transactions. The interests of this group of stockholders may not coincide with our interests or the interests of other
stockholders.

Peter
Friedli, our Chairman of the Board of Directors, and certain entities with which he is affiliated, beneficially own approximately 48% of our outstanding common stock as of
December 31, 2007. Accordingly, Mr. Friedli currently has, and will continue to have, a significant influence over the outcome of all corporate actions requiring stockholder approval.

Certain provisions of Delaware law and of our charter and bylaws contain provisions that could delay and discourage takeover attempts and any attempts to replace our current
management by stockholders.

Certain provisions of our certificate of incorporation and bylaws, and applicable provisions of Delaware corporate law, may make it more difficult for or prevent
a third party from acquiring control of us or changing our Board of Directors and management. These provisions include:



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We
will also be afforded the protections of Section 203 of the Delaware General Corporation Law, which will prevent us from engaging in a business combination with a person who
acquires at least 15% of our common stock for a period of three years from the date such person acquired such common stock, unless advance board or stockholder approval was obtained.

Any
delay or prevention of a change of control transaction or changes in our Board of Directors or management could deter potential acquirors or prevent the completion of a transaction
in which our stockholders could receive a substantial premium over the then current market price for their shares.

Item 1B.    Unresolved Staff Comments.

Not Applicable.

Item 2.    Properties.

Our corporate headquarters are located in Columbia, Maryland, where we lease approximately 61,000 square feet, currently at a rent of approximately
$0.8 million per annum. This lease expires in July 2016, and includes options to extend the term of the lease for two additional five year periods. We also lease approximately 126,000 square
feet in Baltimore, Maryland where we presently manufacture Osteocel. This lease expires in September 2008, by which time we intend to have consolidated our operations in our Columbia, Maryland
facilities. During the second quarter of 2008, we expect to start production of Osteocel in our Columbia, Maryland facility and by the end of the third quarter of 2008, move all of our production
activities to Columbia, Maryland. The lease cost for our Baltimore facilities is approximately $1.0 million per annum.

Item 3.    Legal Proceedings.

Lawsuits and claims are filed against us from time to time in the ordinary course of our business, including without limitation, challenges to our intellectual
property positions. We do not believe that any lawsuits or claims, or proceedings, currently pending against us, individually or in the aggregate, are material, or will have a material adverse effect
on our financial condition or business.

Item 4.    Submission of Matters to a Vote of Securities Holders.

No matters were submitted to a vote of our security holders during the fourth quarter of the year ended December 31, 2007.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issurer Purchases of Equity Securities.

Market Information

Our common stock trades on the NADSAQ Global Market under the symbol "OSIR." The following table lists the high and low sale prices per share for our common stock
based on the closing sales prices as reported on the NASDAQ Global Market for the periods indicated.

2007

2006High

Low

High

LowQuarter EndedMarch 31

$
29.29

11.85

**

**June 30


19.05

10.60

**

**September 30


14.42

11.01

**

**December 31


14.57

9.98

$27.93

$10.00




Stockholders

As of March 7, 2008, there were approximately 270 stockholders of record of our common stock and, according to our estimates, approximately 2,099
beneficial owners of our common stock.

Dividends

We have not paid dividends to our stockholders since our inception and we do not plan to pay cash dividends in the foreseeable future. We currently intend to
retain earnings, if any, to finance our growth.

Unregistered Sales of Securities

In June 2007, we sold 1,757,469 shares of our common stock in a private placement at $11.38 per share, through the efforts of Friedli Corporate
Finance, Inc., raising $20.0 million. The shares were sold under Regulation S of the Securities Act of 1933 to institutional and accredited investors primarily based in
Switzerland. There were no commissions paid on the proceeds raised. The proceeds from the private placement were used to fund further development of our stem cell products.

In
December 2007, we sold 950,000 shares of our common stock in a private placement at $12.37 per share, through the efforts of Friedli Corporate Finance, Inc., raising
$11.8 million. The shares were sold under Regulation S of the Securities Act of 1933 to institutional and accredited investors based in Switzerland. There were no commissions paid on the
proceeds raised. The proceeds from the private placement are intended to be used to fund further development of our stem cell products and general corporate purposes. We deposited the proceeds in two
highly rated financial institutions in the United States.

In
December 2007, we induced the conversion of $18.8 million of our 10% convertible promissory notes, together with accrued interest, into 1,465,837 shares of common stock at the
conversion price of $13.00 per share. In January 2008, we induced the conversion of the remaining $1.2 million of our 10% convertible promissory notes, together with accrued interest, into
85,714 shares of common stock at the conversion price of $14.00 per share. The notes were held by institutional and accredited investors primarily based in Switzerland.

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The
private placements and the debt conversions were led by Friedli Corporate Finance, Inc., of which Peter Friedli, our Chairman of the Board of Directors and largest
shareholder, is President and sole owner. Included among the purchasers of the common stock was Mr. Friedli, who individually invested $14.0 million in the June 2007 private placement
and $1.2 million in the December 2007 private placement, and $8.5 million in the December 2007 debt conversion. New Venturetec, Inc., a Swiss publicly traded company approximately
3% owned by Mr. Friedli who serves as its President, invested $3.0 million in the June 2007 private placement. Our Board of Directors, including all independent directors, but with
Mr. Friedli abstaining, together with our Audit Committee, unanimously approved the private placements and note conversion transactions including to Mr. Friedli and New
Venturetec, Inc., and the arrangements with Friedli Corporate Finance, Inc.

The
securities sold in the two private placements and issued as a result of the debt conversion have not been registered under the United States Securities Act of 1933, as amended (the
"U.S. Securities Act")
or any state securities laws and may not be offered or sold within the United States or to U.S. Persons unless registered under the U.S. Securities Act and applicable state securities laws or unless
an exemption from such registration is available. Pursuant to the terms of the private placements and debt conversions, the holders were provided demand registration rights for the shares of common
stock after such time as we became eligible to effect such registration pursuant to a registration statement on Form S-3 or another "short form" registration statement.

In
January 2008, we filed a Registration Statement on Form S-3 to register 1,904,235 shares of our common stock issued in connection with these two private placements
and the debt conversion. The shares of common stock held by Mr. Friedli and New Venturetec, Inc. were not included in this Registration Statement.

Issuer Purchase of Equity Securities and Use of Proceeds

There were no repurchases by us of our securities during fiscal 2007 or 2006.

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Stock Performance Graph

The following graph shows the cumulative total return, assuming the investment of $100 on August 4, 2006 (the date on which our initial public offering was
declared effective and our common stock began trading on the NASDAQ Global Market), on an investment in each of our common stock, the NASDAQ Composite Index (U.S. and Foreign) and the NASDAQ
Biotechnology Index. The comparisons in the table are required by the SEC and are not intended to forecast or be indicative of possible future performance of our common stock.

GRAPHIC

Securities Authorized for Issuance under Equity Compensation Plans

The information required by Item 201(d) of Regulation S-K, pursuant to paragraph (a) of this Item 5, is incorporated by
reference to the information set forth under the caption "Equity Compensation Plan Information" in the Company's Proxy Statement for the 2008 Annual Meeting of Stockholders, which is anticipated to be
filed pursuant to Regulation 14A no later than one hundred twenty (120) days following the end of the fiscal year reported on.

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Item 6.    Selected Financial Data.

We derived the selected financial data presented below for the periods or dates indicated from our financial statements. Our financial statements for these
periods were audited by Stegman & Company, an independent registered public accounting firm. You should read the data below in conjunction with our financial statements, related notes and other
financial information appearing in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary
Data."

|                                                                                               |                                               | Year Ended December 31, |        
|---------------------------------------------------------------------------------------------- | --------------------------------------------- | ----------------------- | -------
|
|
|Statement of Operations Data:                                                                  |                                               |                         |        
|Product sales                                                                                  |                                               | $                       | 15,240 
|Cost of goods sold                                                                             |                                               |                         | 6,955  
|                                                                                               |                                               |                         |        
|                                                                                               | Gross profit                                  |                         |        
|Revenue from collaborative research licenses and grants                                        |                                               |                         | 2,048  
|                                                                                               |                                               |                         |        
|Operating expenses:                                                                            |                                               |                         |        
|                                                                                               | Research and development                      |                         |        
|                                                                                               | General and administrative and other expenses |                         |        
|                                                                                               |                                               |                         |        
|Total operating expenses                                                                       |                                               |                         | 57,559 
|                                                                                               |                                               |                         |        
|Loss from operations                                                                           |                                               |                         | (47,226
|Interest expense, net                                                                          |                                               |                         | (6,695 
|                                                                                               |                                               |                         |        
|Net loss                                                                                       |                                               | $                       | (53,921
|                                                                                               |                                               |                         |        
|Basic and diluted net loss per share                                                           |                                               | $                       | (1.89  
|                                                                                               |                                               |                         |        
|Weighted average shares of common stock used in computing basic and diluted net loss per share |                                               |                         | 28,489 
|                                                                                               |                                               |                         |        

|
|

|                                                   |  | At December 31, |         
|-------------------------------------------------- |  | --------------- | --------
|
|Balance Sheet Data:                                |  |                 |         
|Cash and short-term investments                    |  | $               | 18,164  
|Working capital                                    |  |                 | 7,247   
|Total assets                                       |  |                 | 37,041  
|Notes payable, less current portion                |  |                 | 1,200   
|Mandatorily redeemable convertible preferred stock |  |                 |        
|Convertible preferred stock                        |  |                 |        
|Accumulated deficit                                |  |                 | (241,424
|Total stockholders' equity (deficit)               |  |                 | 14,336  

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Quarterly Financial Data (Unaudited)

|                                               |                                              | First Quarter |       | Second Quarter |   | Third Quarter |         | Fourth Quarter |      
|---------------------------------------------- | -------------------------------------------- | ------------- | ----- | -------------- | - | ------------- | ------- | -------------- | -----
|2007                                           |                                              |               |       |                |   |               |         |                |      
|                                               | Total revenues                               |               | $     | 2,279          |   | $             | 3,547   |                | $    
|                                               | Product sales                                |               |       | 2,000          |   |               | 3,252   |                |      
|                                               | Cost of goods sold                           |               |       | 901            |   |               | 1503    |                |      
|                                               | Research and development expenses            |               |       | 11,030         |   |               | 10,583  |                |      
|                                               | General and administrative expenses and fees |               |       | 1,506          |   |               | 1,501   |                |      
|                                               | Net loss                                     |               |       | (11,501        | ) |               | (10,458 | )              |      
|**Net loss per common share, basic and diluted |                                              |               | (0.42 | )              |   | (0.37         | )       |                | (0.36
|2006                                           |                                              |               |       |                |   |               |         |                |      
|                                               | Total revenues                               |               | $     | 1,400          |   | $             | 1,987   |                | $    
|                                               | Product sales                                |               |       | 1,105          |   |               | 1,689   |                |      
|                                               | Cost of goods sold                           |               |       | 489            |   |               | 762     |                |      
|                                               | Research and development expenses            |               |       | 4,368          |   |               | 10,922  |                |      
|                                               | General and administrative expenses and fees |               |       | 1,138          |   |               | 1,209   |                |      
|                                               | Net loss                                     |               |       | (5,121         | ) |               | (11,605 | )              |      
|**Net loss per common share, basic and diluted |                                              |               | (0.56 | )              |   | (1.27         | )       |                | (0.75
|2005                                           |                                              |               |       |                |   |               |         |                |      
|                                               | Total revenues                               |               | $     | 385            |   | $             | 1,339   |                | $    
|                                               | Product sales                                |               |       |               |   |               |        |                |      
|                                               | Cost of goods sold                           |               |       |               |   |               |        |                |      
|                                               | Research and development expenses            |               |       | 2,657          |   |               | 3,592   |                |      
|                                               | General and administrative expenses and fees |               |       | 752            |   |               | 487     |                |      
|                                               | Net loss                                     |               |       | (3,868         | ) |               | (3,394  | )              |      
|**Net loss per common share, basic and diluted |                                              |               | (0.43 | )              |   | (0.38         | )       |                | (0.52

---

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Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following is a discussion and analysis of our financial condition, results of operations, liquidity and capital resources for each of the three years in the
period ended December 31, 2007 and significant factors that could affect our prospective financial condition and results of operations. You should read this discussion together with our
financial statements and notes included in "Item 8. Financial Statements and Supplementary Data." Historical results and any discussion of prospective results may not indicate our
future performance. This section contains certain "forward-looking statements" within the meaning of federal securities laws that involve risks and uncertainties, including statements regarding our
plans, objective, goals, strategies and financial performance. Our actual results could differ materially from the results anticipated in these forward-looking statements.

2007 Highlights

We believe cellular therapies have certain advantages over traditional medical approaches. For example, cell therapies can be targeted, avoiding many of the
safety complications arising from systemic treatments. Cell therapies can also be responsive to their environment, turning on or off certain effects as conditions in the surrounding tissue change.
Cell therapies can also be multifaceted. For example, the cells in Prochymal, our leading biologic drug candidate, have demonstrated the ability to not only down regulate inflammation, but also repair
the damage caused by the inflammation.

We
believe the combination of these unique properties will allow us to solve many of the most challenging questions facing medicine today. We have established ourselves as the leader in
the emerging field of cell therapy. We have the only stem cell product on the market, Osteocel, and have treated over 15,000 patients. We have six additional indications in the clinic behind Osteocel.
Three of these clinical trials are in Phase III and each has been granted fast track status by the FDA.

During
2007, we:



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Business Overview

We are a leading stem cell therapeutic company focused on developing and marketing products to treat medical conditions in the inflammatory, orthopedic and
cardiovascular areas. Our marketed product, Osteocel, and our biologic drug candidates utilize mesenchymal stem cells, or MSCs. In July 2005, we launched Osteocel for regenerating bone in orthopedic
indications. We currently have eight clinical trials ongoing. We are currently enrolling patients in three Phase III clinical trials for Prochymal, our lead biologic drug candidate, for:



We
have received Fast Track Status from the FDA for each of these pivotal Phase III trials. During 2007, we initiated a Phase II clinical trial to treat type 1 diabetes and are
continuing to evaluate the results of our Phase I trial to treat acute myocardial infarction. In addition, we have completed a Phase I/II trial for Chondrogen, our biologic drug
candidate for osteoarthritis, reporting statistically significant improvements in pain over placebo. We are currently designing the next phase of clinical testing for Chondrogen.

We
have developed stem cell capabilities in research and development, manufacturing, marketing and distribution. We manufacture Osteocel and, together with AlloSource and Tissue Banks
International, distribute Osteocel in orthopedic indications and jointly distribute Osteocel with Blackstone Medical, Inc., a division of Orthofix International, N.V., for spinal
procedures.

We
have incurred annual operating losses since inception and expect to incur substantial operating losses in the future in connection with the development of our core products. As of
December 31, 2007, we had an accumulated deficit of $241.4 million.

Financial Operations Overview

Revenue

Osteocel is currently our only commercial product. Sales of Osteocel generated revenue of $15.2 million for the year ended December 31, 2007. This
increase in Osteocel revenues was due primarily to increased sales volume.

In
2007 and prior years, we have entered into strategic agreements with other companies for the development and commercialization of select stem cell biologic drug candidates for
specific indications and geographic markets. In 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation ("JDRF") to develop a treatment plan for early onset
type 1 diabetes. Under this agreement, JDRF will provide us with up to $4.0 million in funding. Also in 2007, we entered into a collaborative agreement with Genzyme Corporation to
develop medical countermeasures for nuclear and radiological threats. In 2003, we entered into an agreement with a foreign pharmaceutical company granting it exclusive rights to Prochymal for the
treatment of GvHD in Japan. We recognized $0.5 million of revenue during 2007 and 2005 related to this agreement. We entered into an agreement in 2003 with a major pharmaceutical company
relating to the development of our cardiac biologic drug candidate, and we received a $5.0 million fee for licensing the use of our technology. This agreement was terminated in 2007 and as a
result we regained the worldwide rights to Prochymal for cardiac indications. We recognized $1.4 million in license fee revenue in 2007 and $1.0 million in 2006 and 2005 related to this
agreement.

We
have also recognized revenue from governmental grants for research and in 2005, we recorded $1.4 million in grant revenues from three separate grants. Revenue from research
grants is recognized

55

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as
the related research expenditures are incurred. We are not currently working on any government research grants.

In
early January 2008, we were awarded a contract from the United States Department of Defense ("DoD") to develop and stockpile Prochymal for the repair of gastrointestinal injury
resulting from radiation exposure. Under the terms of the contract, the DoD will provide funding to us in two stages, with an initial amount of $4.2 million expected to be realized during 2008.
If we are successful in obtaining FDA approval for acute radiation syndrome, the contract provides for the purchase of up to 20,000 doses of Prochymal, at $10,000 per dose, in four 5,000 dose
increments.

Other
than Osteocel, we have no commercial products for sale. A substantial portion of our revenue in the future will be dependent on the approval and sale of our biologic drug
candidates. Our revenue may vary substantially from quarter to quarter and from year to year. We believe that period-to-period comparisons of our results of operations are not
meaningful and should not be relied upon as indicative of our future performance.

Cost of Goods Sold

Our cost of goods sold relate to direct costs of producing Osteocel. Cost of goods sold consist primarily of the costs of obtaining tissue and other chemicals and
supplies, direct labor and allocated costs of our clean-room facilities and overhead.

Research and Development Costs

Our research and development costs consist of expenses incurred in identifying, developing and testing biologic drug candidates. These expenses consist primarily
of salaries and related expenses for personnel, fees paid to professional service providers for independent monitoring and analysis of our clinical trials, costs of contract research and
manufacturing, costs of facilities, and the costs of manufacturing clinical batches of biologic drug candidates, quality control supplies and material to expand biologic drug candidates.

Consistent
with our focus on the development of biologic drug candidates with potential uses in multiple indications, many of our costs are not attributable to a specifically identified
product. We use our employee and infrastructure resources across several projects. Accordingly, we do not account for internal research and development costs on a
project-by-project basis. As a result, we cannot state precisely the total costs incurred for each of our clinical and preclinical projects on a
project-by-project basis. From inception through December 31, 2007, we incurred aggregate research and development costs of approximately $234 million.

We
expect our research and development expenses to continue to increase substantially in the future, as we expand our clinical trial activity, as our biologic drug candidates advance
through the development cycle and as we invest in additional product opportunities and research programs. Clinical trials and preclinical studies are time-consuming and expensive. Our
expenditures on current and future preclinical and clinical development programs are subject to many uncertainties. We test our products in several preclinical studies, and we then conduct clinical
trials for those biologic drug candidates that we determine to be the most promising. As we obtain results from clinical trials, we may elect to discontinue or delay trials for some biologic drug
candidates in order to focus our resources on more promising biologic drug candidates. Completion of clinical trials may take several years or more, but the length of time generally varies
substantially according to the type, size of trial and intended use of a biologic drug candidate. The cost of clinical trials may vary significantly over the life of a project as a result of a variety
of factors, including:



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As
a result of the uncertainties discussed above, we are unable to determine with any significant degree of certainty the duration and completion costs of our research and development
projects or when and to what extent we will generate revenues from the commercialization and sale of any of our biologic drug candidates.

General and Administrative Expenses

General and administrative expenses consist primarily of the costs associated with our general management, including salaries, allocations of facilities and
related costs, and professional fees such as legal and accounting expenses. In anticipation of and since the closing of our initial public offering in August 2006, we began to incur increases in our
general and administrative expense for legal and accounting compliance costs, investor relations and other activities associated with operating as a publicly traded company. Continued increases will
also likely result from the hiring of additional operational, financial, accounting, facilities engineering and information systems personnel.

Interest Income (Expense), Net

Interest income consists of interest earned on our cash and short-term investments. Interest expense consists of interest incurred on capital leases
and other debt financings. We pay interest on our bank loan, capital leases and any convertible long-term debt.

Income Taxes

We have not recognized any deferred tax assets or liabilities in our financial statements since we cannot assure their future realization. Because realization of
deferred tax assets is dependent upon future earnings, a full valuation allowance has been recorded on the net deferred tax assets, which relate primarily to net operating loss and research and
development carry-forwards. In the event that we become profitable within the next several years, we have net deferred tax assets (before a 100% valuation allowance) of approximately
$93.6 million that may be utilized prior to us having to recognize any income tax expense or make payments to the taxing authorities. Utilization of our net operating loss carry-forwards in any
one year may be limited under IRC Section 382, and we could be subject to the alternative minimum tax.

Critical Accounting Policies

General

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which we have prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition,
inventory valuation, deferred tax assets, share-based compensation, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable.
These results form the basis for making judgments

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about
the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We
believe that the following critical accounting policies reflect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

Our revenue recognition policies are governed by the Securities and Exchange Commission's, or SEC, Staff Accounting Bulletin No. 101, Revenue Recognition in
Financial Statements, as amended by SEC Staff Accounting Bulletin No. 104,Revenue
Recognition.

We
have one commercial product on the market. We recognize revenue on sales when legal title to the product has passed to the customer, which is usually when the product is shipped from
our Baltimore, Maryland facilities. We have agreements with our customers that specify the terms of sale, including price.

Revenues
from collaborative agreements and grants are recognized as earned upon either the incurring of reimbursable expenses directly related to the particular research plan or the
completion of certain development milestones as defined within the terms of the collaborative agreement. Payments received in advance of research performed are designated as deferred revenue. We
recognize non-refundable upfront license fees and certain other related fees on a straight-line basis over the development period. Fees associated with substantive at risk,
performance based milestones are recognized as revenue upon their completion, as defined in the respective agreements. Incidental assignment of technology rights is recognized as revenue at the time
of receipt.

Milestone
payments that are based on designated achievement points and that are considered at risk and substantive at the inception of the collaboration are recognized as earned when the
corresponding payment is considered reasonably assured. We evaluate whether milestone payments are at risk and substantive based on the contingent nature of the milestone, specifically reviewing
factors such as the technological and commercial risk that must be overcome and the level of the investment required. Milestone payments that are not considered at risk and substantive are recognized,
when achieved, in proportion to the percentage of the collaboration completed through the date of achievement. The remainder of the milestone payment is recognized as services are performed over the
remaining term of the collaboration.

Royalties
for the use of our MSCs for clinical research purposes are recognized when earned, however, such amounts have not been material and are not expected to be material in the
future. Additionally, we may receive royalty payments under our collaborative arrangements upon sales of product.

We
evaluate all collaborative agreements on a quarterly basis to determine the appropriate revenue recognition for that period. The evaluation includes all of the potential revenue
components from each specific collaborative agreement.

Accounts Receivable

Our accounts receivable are reported at their net realizable value. As of December 31, 2007 and 2006, there was no allowance for doubtful accounts as we
believe the reported amounts are fully collectible. During the year ended December 31, 2006, we recognized $3 of bad debt expense. We did not recognize any bad debt expense for the years ended
December 31, 2007 and 2005. Accounts receivable balances are not collateralized.

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Share-Based Compensation

Effective January 1, 2006, we adopted Financial Accounting Standards Board ("FASB") Statement No. 123(R) and began to recognize expense in our
statement of operations associated with all share-based awards based on the grant-date fair value of the awards. Compensation expense related to share-based awards is recognized on a
straight-line basis based on the value of share awards that are scheduled to vest during the requisite service period. We use the Black-Scholes option pricing model to estimate the fair
value of share-based awards. The determination of the fair value of share-based awards using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex
and subjective variables. Those assumptions include estimating:



We
have reviewed each of these assumptions carefully and based on the analysis discussed in Note 6"Share-Based Compensation" to our financial statements determined
our best estimate for these variables. Of these assumptions, the expected term of the option, forfeiture rate and expected volatility of our common stock are the most difficult to estimate since they
are based on the exercise behavior of option holders and the expected performance of our common stock. An increase in the volatility of our common stock will increase the amount of compensation
expense on new awards. An increase in the expected term of the awards will also cause an increase in compensation expense. An increase in the forfeiture rate will cause a decrease in compensation
expense as the employee is not likely to hold the option for the contractual term. Risk-free interest rates are less difficult to estimate, but an increase in the risk-free
interest rate will increase compensation expense.

Under
Statement No. 123(R), share-based compensation expense is based on awards ultimately expected to vest and must be reduced for estimated forfeitures. Forfeitures are
estimated at the time an award is granted and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be
between 0% and 20% based on historical experience. Changes in our estimated forfeiture rate could materially impact our estimate of the fair value of share-based compensation and consequently, the
related amount of expense recognized in our statements of operations.

Significant New Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") 157,"Fair Value
Measurements."SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about
fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. We do not expect
the implementation of SFAS 157 to have a material impact on our financial statements.

In
June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").
FIN 48 clarifies when tax benefits should be recorded in financial statements, requires certain disclosures of uncertain tax matters and indicates how any tax reserves should be classified in a
balance sheet. On January 1, 2007, we adopted FIN 48. We have determined that adoption of FIN 48 did not have any impact on our financial condition or results of operations. It is
our policy to recognize interest and penalties related to unrecognized tax liabilities within income tax expense in the statements of operations.

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In
February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial Assets and Liabilities." SFAS 159 permits
entities to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility
in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This pronouncement is effective as of the beginning of
an entity's first fiscal year beginning after November 15, 2007. We do not expect the implementation of SFAS 159 to have a material impact on our financial position or results of
operations.

In
June 2007, the FASB ratified a consensus opinion reached by the Emerging Issues Task Force ("EITF") on EITF Issue 07-3,"Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities."The guidance in EITF Issue 07-3 requires us to
defer and capitalize nonrefundable advance payments made for goods or services to be used in research and development activities until the goods have been delivered or the related services have been
performed. If the goods are no longer expected to be delivered nor the services expected to be performed, we would be required to expense the related capitalized advance payments. The consensus in
EITF Issue 07-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2007 and is to be applied prospectively to new contracts
entered into on or after December 15, 2007. Early adoption is not permitted. Retrospective application of EITF Issue 07-3 is also not permitted. We intend to adopt EITF Issue
07-3 effective January 1, 2008. The impact of applying this consensus will depend on the terms of the our future research and development contractual arrangements entered into on or
after December 15, 2007.

In
December 2007, the FASB ratified a consensus reached by the EITF on Issue 07-1, "Accounting for Collaborative
Arrangements."The EITF concluded on the definition of a collaborative arrangement and that revenues and costs incurred with third parties in connection with collaborative
arrangements would be presented gross or net based on the criteria in EITF 99-19 and other accounting literature. Based on the nature of the arrangement, payments to or from
collaborators would be evaluated and its terms, the nature of the entity's business, and whether those payments are within the scope of other accounting literature would be presented. Companies are
also required to disclose the nature and purpose of collaborative arrangements along with the accounting policies and the classification and amounts of significant financial-statement amounts related
to the arrangements. Activities in the arrangement conducted in a separate legal entity should be accounted for under other accounting literature; however required disclosure under
EITF 07-1 applies to the entire collaborative agreement. EITF 07-1 is effective for us January 1, 2008 and is to be applied retrospectively to all periods
presented for all collaborative arrangements existing as of the effective date. We do not expect the adoption of EITF 07-1 to have a material impact on our financial statements.

In
December 2007, the FASB issued SFAS 141, Revised 2007 (SFAS 141R),"Business Combinations."SFAS 141R's objective
is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects.
SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after December 15, 2008. We do not expect the implementation of SFAS 141R to have
a material impact on our financial statements.

In
December 2007, the FASB issued SFAS 160,"Noncontrolling Interests in Consolidated Financial Statements".SFAS 160's
objective is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting
and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 shall be effective for fiscal years and interim periods within
those fiscal years, beginning on or after December 15, 2008. We do not expect the implementation of SFAS 160 to have a material impact on our financial statements.

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Results of Operations

Year ended December 31, 2007 compared to December 31, 2006

Revenue

Total revenues increased 83% to $17.3 million for the twelve months ended December 31, 2007, compared to $9.5 million in the corresponding
period in 2006. Our revenues in 2007, resulted primarily from $15.2 million generated from the sale of Osteocel and the recognition of $2.0 million in licensing fees and royalties. In
the twelve months ended December 31, 2006, we recognized $8.2 million from the sale of Osteocel and $1.2 million in license fees and royalties. The 2007 license fees and royalties
includes a $0.5 million milestone payment received from JCR Pharmaceuticals and the recognition of the unamortized license fees associated with our collaborative agreement with Boston
Scientific Corporation, which was terminated in December 2007.

Cost of Goods Sold

Cost of goods sold were $7.0 million for the twelve months ended December 31, 2007 compared to $3.7 million in the prior year. The cost of
goods sold associated with sales of Osteocel is comprised of payments to tissue banks, direct labor costs and the costs of processing, testing and preserving Osteocel, plus allocated costs of our
facilities and overhead. The gross margin on Osteocel sales for the twelve months ended December 31, 2007 was 54%, compared with 55% for 2006.

Research and Development Expenses

Research and development expenses were $50.9 million for the twelve months ended December 31, 2007 compared to $37.6 million in the prior
year. The increase in research and development expenses in 2007 reflects the increased number of clinical trials in process versus the prior year. In 2007, we incurred costs associated with the
enrollment of three Phase III clinical trials for Prochymal, manufacturing the biologic drug candidates for use in our clinical trials, as well as costs associated with our Phase I and
Phase II trials and other preclinical development activities.

General and Administrative Expenses

General and administrative expenses were $6.6 million for the twelve months ended December 31, 2007 compared to $4.3 million in the prior
year. The increase in 2007 was attributable to additional personnel and related costs to support our growth and costs incurred in connection with being a public company.

Related Party Expenses

During 2007, we paid Peter Friedli, the Chairman of our Board of Directors and largest shareholder, 5,000 shares of our common stock, valued at $23.62 per share,
for board related services. Fees paid to related parties were $0.5 million for the twelve months ended December 31, 2006 and were made in connection with pre-IPO financings.
Also in 2006, we recorded $3.5 million in non-cash charges related to warrants issued to our chairman that were priced and vested upon completion of our initial public offering and
$0.2 million in share-based compensation for stock awards for services of our board of directors.

Interest Income (Expense), Net

Interest income (expense), net was $6.7 million for the twelve months ended December 31, 2007 compared to $4.7 million in the prior year. The
2007 costs include a non-cash charge of $4.8 million resulting from the induced conversion of $18.8 million of our convertible promissory notes into common stock and
$0.3 million of previously deferred debt financing fees. The 2006 costs include $2.7 million of previously deferred debt financing costs and premiums associated with debt that was

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converted
into common stock upon the completion of our initial public offering. Exclusive of these charges, net interest expense during 2007 was $1.9 million, compared with $2.0 million
in 2006.

Year ended December 31, 2006 compared to December 31, 2005

Revenue

Total revenues increased 138% to $9.5 million for the twelve months ended December 31, 2006, compared to $4.0 million in the corresponding
period in 2005. Our revenues in 2006 resulted primarily from $8.3 million generated from the sale of Osteocel and the recognition of $1.2 million in licensing fees and royalties. In the
twelve months ended December 31, 2005, we recognized $1.0 million from the sale of Osteocel and $3.0 million in license fees and royalties and government grants.

Cost of Goods Sold

Cost of goods sold were $3.7 million for the twelve months ended December 31, 2006 compared to $0.4 million in the prior year. The cost of
goods sold associated with sales of Osteocel was comprised of payments to tissue banks, direct labor costs and the costs of processing, testing and preserving Osteocel, plus allocated costs of our
facilities and overhead. The gross margin on Osteocel sales for the twelve months ended December 31, 2006 was 55%, compared with 54% for 2005.

Research and Development Expenses

Research and development expenses were approximately $37.6 million for the twelve months ended December 31, 2006 compared to $16.9 million in
the prior year. The increase in research and development expenses in 2006 reflects the increased number of clinical trials in process versus the prior year. In 2006, we incurred costs associated with
the enrollment of a Phase II trial for Prochymal as an add-on therapy to steroids for the first-line treatment of acute GvHD, a Phase II trial for Prochymal for
treatment of steroid refractory GvHD, a Phase II trial for Prochymal for treatment of Crohn's disease, a Phase I/II clinical trial for Chondrogen, and a Phase I clinical trial for
Prochymal for the treatment of heart disease.

General and Administrative Expenses

General and administrative expenses were $4.3 million for the twelve months ended December 31, 2006 compared to $2.2 million in the prior
year. The increase in 2006 includes $0.9 million of non-cash charges associated with the completion of our initial public offering. Exclusive of these charges, general and
administrative expenses in 2006 were $3.5 million and the increase over the prior year was attributable to additional personnel and related costs to support our growth and costs incurred in
connection with being a public company.

Related Party Expenses

Fees paid to related parties were $0.5 million for the twelve months ended December 31, 2006 compared to $0.1 million in the prior year. In
2006, we recorded $3.5 million in non-cash charges related to warrants issued to our chairman that were priced and vested upon completion of our initial public offering and
$0.2 million in share-based compensation for stock awards for services of our board of directors.

Interest Income (Expense), Net

Interest expense, net was $4.7 million for the twelve months ended December 31, 2006 compared to $4.3 million in the prior year. The 2006
costs include $2.7 million of previously deferred debt financing costs and premiums associated with debt that was converted into common stock upon the completion of our initial public offering.
Exclusive of these charges, net interest expense during 2006 was $2.0 million, a decrease of $2.3 million compared to 2005. This decrease was the result of higher

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interest
income related to the investment of the proceeds of the initial public offering and the $21.8 million decrease in debt, which was converted into common stock upon the completion of the
initial public offering in early August 2006.

Liquidity and Capital Resources

Liquidity.

At December 31, 2007, we had $0.7 million in cash and $17.5 million in short-term investments. In addition to the cash and
short-term investments, at December 31, 2007, we had availability of $30.0 million under our line of credit with Friedli Corporate Finance, Inc.

At
December 31, 2007, our short-term debt was $6.5 million.

Cash Flows.

|                                                    |  | Years Ended December 31, |        
|--------------------------------------------------- |  | ------------------------ | -------
|
|
|Net cash used in operating activities               |  | $                        | (46,518
|Net cash provided by (used in) investing activities |  |                          | 16,305 
|Net cash provided by financing activities           |  |                          | 30,203 

We
have historically financed our research and development activities through cash flows provided by financing activity and have not generated net cash from operating activities since
inception. Starting in 2005, we began to generate revenues and segment profits from the manufacture and sale of Osteocel, however during the same periods, we have increased our clinical trial
activities as we strive to bring our biologic drug candidates to market. We believe these trends will continue in the foreseeable future.

Net
cash used in operating activities was $46.5 million for the twelve months ended December 31, 2007 primarily reflecting our net loss of $53.9 million; partially
offset by $6.9 million in non-cash interest, $1.3 million in non-cash stock-based compensation expense and $2.0 million in depreciation and amortization.
Other long-term liabilities decreased by $1.1 million, reflecting the reclassification of the accrued interest on the Boston Scientific credit line which was converted into
short-term debt upon the termination of our collaborative agreement. Net cash used for operating activities was $35.3 million for the twelve months ended December 31, 2006.
Net cash used in operating activities for 2006 primarily reflected our net loss of $45.0 million, partially offset by $5.7 million in non-cash interest expense and
$5.5 million of non-cash share-based payments.

Net
cash provided by investing activities was $16.3 million for the twelve months ended December 31, 2007. Net cash provided by investing activities for the twelve months
ended December 31, 2006 was $2.6 million. Net cash provided by investing activities in 2007 includes cash flows from the net sale of $21.0 million of short-term
investments, less purchases of property and equipment of
$4.7 million. In 2006, we had net sales of short-term investments during the year of $4.3 million and purchase of property and equipment of $1.7 million.

Net
cash provided by financing activities was $30.2 million for the twelve months ended December 31, 2007, principally from the two private placements of our common stock
which raised $31.7 million. Net cash provided by financing activities was $32.8 million for the twelve months ended December 31, 2006 and consisted principally of
$34.4 million in net proceeds from our initial public offering and the issuance of $20.0 million of convertible promissory notes in October 2006, which was offset by the redemption of
the $20.6 million convertible note, also in October 2006.

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Capital Resources.

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



As
a result of these factors, we will need to seek additional funding prior to our becoming cash flow positive on an operational basis. We would likely seek such funding through public
or private financings or some combination of them. We might also seek funding through collaborative arrangements if determined to be necessary or appropriate. Additional funding may not be available
to us on acceptable terms, or at all. If we obtain capital through collaborative arrangements, these arrangements could require us to relinquish rights to our technologies or biologic drug candidates.
If we raise capital through the sale of equity, or securities convertible into equity, dilution to our then existing stockholders would result. If we raise additional capital through the incurrence of
debt, we would likely become subject to covenants restricting our business activities, and holders of debt instruments would have rights and privileges senior to those of our equity investors. In
addition, servicing the interest and repayment obligations under these borrowings would divert funds that would otherwise be available to support research and development, clinical or
commercialization activities.

If
we are unable to obtain adequate financing on a timely basis, we may be required to delay, reduce the scope of or eliminate one or more of our programs, any of which could have a
material adverse effect on our business, financial condition and results of operations.

We
expect that our available cash and interest income, including the availability under our line-of-credit, will be sufficient to finance currently planned
activities through at least early 2009. These estimates are based on certain assumptions, which could be negatively impacted by the matters discussed under "Risk Factors."

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 "Risk Factors."

Off-Balance Sheet Arrangements.

We have no off-balance sheet financing arrangements and we have not entered into any transactions involving unconsolidated subsidiaries or special
purpose entities.

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Future Contractual Obligations

The following table sets forth our estimates as to the amounts and timing of contractual payments for our most significant contractual obligations at
December 31, 2007. The information in the table reflects future unconditional payments and is based on the terms of the relevant agreements, appropriate classification of item under generally
accepted accounting principles currently in effet and certain assumptions such as interest rates. Future events could cause actual payments to differ from these amounts.

|                                   |  | Payment Due by Fiscal Year
|---------------------------------- |  | --------------------------
|
|
|Long-term debt                     |  | $                         
|Operating leasefacilities         |  |                           
|Capital leasesfacilities          |  |                           
|Capital leasesequipment           |  |                           
|Interest payments                  |  |                           
|                                   |  |                           
|Total contractual cash obligations |  | $                         
|                                   |  |                           

Effect of Inflation.

Inflation and changing prices are not generally a material factor affecting our business. General operating expenses such as salaries, employee benefits and lease
costs are, however, subject to normal inflationary pressures.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.



Due to the short duration of our investment portfolio and the high quality of our investments, 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.

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-collectability and establishment of appropriate allowances in connection with our internal controls and policies.



We conduct clinical trial activities in areas that operate in a functional currency other than the United States dollar (USD). As a result, when the USD rises and
falls against the functional currencies of these other nations, our costs will either increase or decrease by the relative change in the exchange rate. Foreign currency gains and losses were not
significant during the three years ended December 31, 2007, and at the present time, we have elected not to hedge our exposure to foreign currency fluctuations.



We do not enter into hedging or derivative instrument arrangements.

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Item 8.    Financial Statements and Supplementary Data.

Osiris Therapeutics, Inc.    Financial Statements    INDEX

|                                                                                                  |  | Page
|------------------------------------------------------------------------------------------------- |  | ----
|Management's Report on Internal Control Over Financial Reporting                                  |  | 67  
|Report of Independent Registered Public Accounting FirmInternal Control Over Financial Reporting |  | 68  
|Report of Independent Registered Public Accounting FirmAudited Financial Statements              |  | 69  
|Balance Sheets at December 31, 2007 and 2006                                                      |  | 70  
|Statements of Operations for the years ended December 31, 2007, 2006 and 2005                     |  | 71  
|Statements of Stockholders' Equity (Deficit) for the years ended December 31, 2007, 2006 and 2005 |  | 72  
|Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005                     |  | 73  
|Notes to Financial Statements                                                                     |  | 74  

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MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for performing an assessment of the
effectiveness of internal control over financial reporting as of December 31, 2007. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our system of internal control over
financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements. Under the supervision and with
the participation of our management, including our Chief Executive Officer and Interim Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial
reporting as of December 31, 2007 based on the framework inInternal ControlIntegrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO"). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of
December 31, 2007.

Stegman &
Company, the independent registered public accounting firm that audited our financial statements, has issued an attestation report on their assessment of internal
controls over financial reporting, which is included elsewhere in this Annual Report.

Date:  March 13,
2008

| |  |  | /s/C. RANDAL MILLSC. Randal Mills, Ph.D. President and Chief Executive Officer
(principal executive officer)
| |  |  | ------------------------------------------------------------------------------------------------------------
| |  |  | /s/PHILIP R. JACOBY, JR.Philip R. Jacoby, Jr. Interim Chief Financial Officer
(principal financial officer) 

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GRAPHIC

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM  INTERNAL CONTROL OVER FINANCIAL REPORTING

To
the Board of Directors and Stockholders
Osiris Therapeutics, Inc.
Columbia, Maryland

We
have audited Osiris Therapeutics, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Frameworkissued
by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Osiris
Therapeutics, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial
reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In
our opinion, Osiris Therapeutics, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on
criteria established inInternal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO").

We
have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the balance sheets and the related statements of operations,
stockholders' equity (deficit), and cash flows of Osiris Therapeutics, Inc., and our report dated March 13, 2008 expressed an unqualified opinion.

|                                   |  |                      
|---------------------------------- |  | ---------------------
|                                   |  | /s/ STEGMAN & COMPANY
|Baltimore, Maryland
March 13, 2008 |  |                      

GRAPHIC

68

---





GRAPHIC

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM  FINANCIAL STATEMENTS

Board
of Directors and Stockholders
Osiris Therapeutics, Inc.
Columbia, Maryland

We
have audited the accompanying balance sheets of Osiris Therapeutics, Inc. as of December 31, 2007 and 2006, and the related statements of operations, stockholders'
equity (deficit) and cash flows for each of the years in the three-year period ended December 31, 2007. Osiris Therapeutics, Inc.'s management is responsible for these
financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Osiris Therapeutics, Inc. as of December 31,
2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles
generally accepted in the United States of America.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Osiris Therapeutics, Inc.'s internal control over
financial reporting as of December 31, 2007, based on criteria established inInternal ControlIntegrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), and our report dated March 13, 2008 expressed an unqualified opinion.

|                                   |  |                      
|---------------------------------- |  | ---------------------
|                                   |  | /s/ STEGMAN & COMPANY
|Baltimore, Maryland
March 13, 2008 |  |                      

GRAPHIC

69

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OSIRIS THERAPEUTICS, INC.        BALANCE SHEETS        (amounts in thousands)

|                                                                   |                                                                                                                                                 | December 31,                               |      
|------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | -----
|
|ASSETS                                                             |                                                                                                                                                 |                                            |      
|Current assets:                                                    |                                                                                                                                                 |                                            |      
|                                                                   | Cash                                                                                                                                            |                                            | $    
|                                                                   | Short-term investments                                                                                                                          |                                            |      
|                                                                   | Accounts receivable                                                                                                                             |                                            |      
|                                                                   | Inventory                                                                                                                                       |                                            |      
|                                                                   | Other current assets                                                                                                                            |                                            |      
|                                                                   |                                                                                                                                                 |                                            |      
|                                                                   |                                                                                                                                                 | Total current assets                       |      
|                                                                   |                                                                                                                                                 |                                            |      
|Property and equipment, net                                        |                                                                                                                                                 |                                            | 6,616
|Restricted cash                                                    |                                                                                                                                                 |                                            | 280  
|Deferred financing costs, net                                      |                                                                                                                                                 |                                            | 19   
|Other assets                                                       |                                                                                                                                                 |                                            | 1,385
|                                                                   |                                                                                                                                                 |                                            |      
|                                                                   |                                                                                                                                                 | Total assets                               |      
|                                                                   |                                                                                                                                                 |                                            |      
|LIABILITIES AND STOCKHOLDERS' EQUITY                               |                                                                                                                                                 |                                            |      
|Current liabilities:                                               |                                                                                                                                                 |                                            |      
|                                                                   | Accounts payable and accrued expenses                                                                                                           |                                            | $    
|                                                                   | Note payable, current portion                                                                                                                   |                                            |      
|                                                                   | Capital lease obligations, current portion                                                                                                      |                                            |      
|                                                                   | Deferred revenue, current portion                                                                                                               |                                            |      
|                                                                   |                                                                                                                                                 |                                            |      
|                                                                   |                                                                                                                                                 | Total current liabilities                  |      
|Notes payable and long-term line-of-credit, net of current portion |                                                                                                                                                 |                                            | 1,200
|Capital lease obligations, net of current portion                  |                                                                                                                                                 |                                            | 11   
|Deferred revenue, net of current portion                           |                                                                                                                                                 |                                            |     
|Long-term interest payable and other liabilities                   |                                                                                                                                                 |                                            |     
|                                                                   |                                                                                                                                                 |                                            |      
|                                                                   |                                                                                                                                                 | Total liabilities                          |      
|                                                                   |                                                                                                                                                 |                                            |      
|Stockholders' equity:                                              |                                                                                                                                                 |                                            |      
|                                                                   | Convertible preferred stock, issuable in series, $0.001 par value, 16,250 shares authorized, 12,250 shares designated and no shares outstanding |                                            |      
|                                                                   | Common stock, $0.001 par value, 90,000 shares authorized 31,648 and 27,321 shares outstanding in 2007 and 2006                                  |                                            |      
|                                                                   | Additional paid-in-capital                                                                                                                      |                                            |      
|                                                                   | Accumulated deficit                                                                                                                             |                                            |      
|                                                                   |                                                                                                                                                 |                                            |      
|                                                                   |                                                                                                                                                 | Total stockholders' equity                 |      
|                                                                   |                                                                                                                                                 |                                            |      
|                                                                   |                                                                                                                                                 | Total liabilities and stockholders' equity |      
|                                                                   |                                                                                                                                                 |                                            |      

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

70

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OSIRIS THERAPEUTICS, INC.        STATEMENTS OF OPERATIONS        (amounts in thousands, except per share data)

|                                                                             |                            | Years Ended December 31,             |        
|---------------------------------------------------------------------------- | -------------------------- | ------------------------------------ | -------
|
|Product sales                                                                |                            | $                                    | 15,240 
|                                                                             | Cost of goods sold         |                                      |        
|                                                                             |                            |                                      |        
|                                                                             | Gross profit               |                                      |        
|                                                                             |                            |                                      |        
|Revenue from collaborative research licenses, royalties and grants           |                            |                                      | 2,048  
|                                                                             |                            |                                      |        
|Operating expenses:                                                          |                            |                                      |        
|                                                                             | Research and development   |                                      |        
|                                                                             | General and administrative |                                      |        
|Fees paid to related parties                                                 |                            |                                      |       
|Share-based payments to related party                                        |                            |                                      | 118    
|                                                                             |                            |                                      |        
|                                                                             |                            | Total operating expenses             |        
|                                                                             |                            |                                      |        
|Loss from operations                                                         |                            |                                      | (47,226
|Interest income (expense):                                                   |                            |                                      |        
|                                                                             | Interest income            |                                      |        
|                                                                             | Interest expense           |                                      |        
|                                                                             |                            |                                      |        
|                                                                             |                            | Total interest expense, net          |        
|                                                                             |                            |                                      |        
|                                                                             |                            | Net loss                             |        
|                                                                             |                            |                                      |        
|                                                                             |                            | Basic and diluted net loss per share |        
|                                                                             |                            |                                      |        
|Weighted average common shares outstanding, in thousands (basic and diluted) |                            |                                      | 28,489 
|                                                                             |                            |                                      |        

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

71

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OSIRIS THERAPEUTICS, INC.        STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)        (amounts in thousands, except for share data)

|                                                                                                                    |  | Convertible Preferred Stock |  | Common Stock |         |   |            |  |   |    |  | Total
Stockholders'
Equity
(Deficit) |        
|------------------------------------------------------------------------------------------------------------------- |  | --------------------------- |  | ------------ | ------- | - | ---------- |  | - | -- |  | ------------------------------------ | -------
|
|
|Balance at January 1, 2005                                                                                          |  | 3,093,544                   |  | $            | 15,243  |   | 8,900,358  |  | $ | 9  |  | $                                    | 94,386 
|Exercise of options to purchase common stock ($0.40-$0.80 per share)                                                |  |                            |  |              |        |   | 27,148     |  |   |   |  |                                      | 12     
|Share-based paymentdirector services ($0.40 per share)                                                             |  |                            |  |              |        |   | 45,000     |  |   |   |  |                                      | 18     
|Conversion of restricted stock units to management ($0.40 per share)                                                |  |                            |  |              |        |   | 125,000    |  |   |   |  |                                      | 50     
|Issuance of convertible preferred sstock Series E ($2.50 per share)                                                 |  | 7,557,000                   |  |              | 17,503  |   |           |  |   |   |  |                                      |       
|Redemption premium on mandatorily redeemable convertible preferred sstock, Series D, redeemable at $20.00 per share |  |                            |  |              |        |   |           |  |   |    |  |                                      | (58,305
|Deferred compensation from stock option grants                                                                      |  |                            |  |              |        |   |           |  |   |    |  |                                      | 247    
|Forfeiture of stock options                                                                                         |  |                            |  |              |        |   |           |  |   |   |  |                                      | (17    
|Amorization of deferred compensation from stock option grants                                                       |  |                            |  |              |        |   |           |  |   |   |  |                                      | 13     
|Net loss                                                                                                            |  |                            |  |              |        |   |           |  |   |   |  |                                      |       
|                                                                                                                    |  |                             |  |              |         |   |            |  |   |    |  |                                      |        
|Balance at December 31, 2005                                                                                        |  | 10,650,544                  |  |              | 32,746  |   | 9,097,506  |  |   | 9  |  |                                      | 36,404 
|Exercise of options to purchase common stock ($0.40-$0.80 per share)                                                |  |                            |  |              |        |   | 178,378    |  |   |   |  |                                      | 73     
|Exercise of warrants to purchase common stock ($0.40 per share)                                                     |  |                            |  |              |        |   | 875,000    |  |   | 1  |  |                                      | 349    
|Share-based paymentdirector services ($6.84$11.00 per share)                                                      |  |                            |  |              |        |   | 22,807     |  |   |   |  |                                      | 198    
|Share-based paymentconsulting services ($6.84 per share)                                                           |  |                            |  |              |        |   | 6,250      |  |   |   |  |                                      | 43     
|Reclassification due to adoption of new accounting standard                                                         |  |                            |  |              |        |   |           |  |   |   |  |                                      | (277   
|Initial public offering of common stock, net of offering costs                                                      |  |                            |  |              |        |   | 3,500,000  |  |   | 3  |  |                                      | 34,399 
|Conversion of convertible preferred stock into common stock                                                         |  | (10,650,544                 |  |              | (32,746 | ) | 2,833,914  |  |   | 3  |  |                                      | 32,743 
|Conversion of mandatorily redeemable preferred stock into common stock                                              |  |                            |  |              |        |   | 8,033,388  |  |   | 8  |  |                                      | 64,259 
|Conversion of convertible notes payable into common stock                                                           |  |                            |  |              |        |   | 2,774,076  |  |   | 3  |  |                                      | 25,320 
|Share-based paymentemployee compensation                                                                           |  |                            |  |              |        |   |           |  |   |   |  |                                      | 1,725  
|Share-based paymentrelated party                                                                                   |  |                            |  |              |        |   |           |  |   |   |  |                                      | 3,527  
|Net loss                                                                                                            |  |                            |  |              |        |   |           |  |   |   |  |                                      |       
|                                                                                                                    |  |                             |  |              |         |   |            |  |   |    |  |                                      |        
|Balance at December 31, 2006                                                                                        |  |                            |  |              |        |   | 27,321,319 |  |   | 27 |  |                                      | 198,763
|Exercise of options to purchase common stock ($0.40-$6.84 per share)                                                |  |                            |  |              |        |   | 141,312    |  |   |   |  |                                      | 60     
|Share-based paymentdirector services ($23.62 per share)                                                            |  |                            |  |              |        |   | 12,500     |  |   |   |  |                                      | 295    
|Issuance of common stock in private placements to overseas investors ($11.38$12.37 per share)                      |  |                            |  |              |        |   | 2,707,469  |  |   | 3  |  |                                      | 31,698 
|Induced conversion of convertible notes payable into common stock ($13.00 per share)                                |  |                            |  |              |        |   | 1,465,837  |  |   | 2  |  |                                      | 23,867 
|Share-based paymentemployee compensation                                                                           |  |                            |  |              |        |   |           |  |   |   |  |                                      | 1,045  
|Net loss                                                                                                            |  |                            |  |              |        |   |           |  |   |   |  |                                      |       
|                                                                                                                    |  |                             |  |              |         |   |            |  |   |    |  |                                      |        
|Balance at December 31, 2007                                                                                        |  |                            |  | $            |        |   | 31,648,437 |  | $ | 32 |  | $                                    | 255,728
|                                                                                                                    |  |                             |  |              |         |   |            |  |   |    |  |                                      |        

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

72

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OSIRIS THERAPEUTICS, INC.        STATEMENTS OF CASH FLOWS        (amounts in thousands)

|                                                                      |                                                                                                                                                     | Years Ended December 31,                     |                                         
|--------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------
|
|Cash flows from operating activities:                                 |                                                                                                                                                     |                                              |                                         
|                                                                      | Net loss                                                                                                                                            |                                              | $                                       
|                                                                      | Adjustments to reconcile net loss to net cash used in operating activities:                                                                         |                                              |                                         
|                                                                      |                                                                                                                                                     | Depreciation and amortization                |                                         
|                                                                      |                                                                                                                                                     | Non cash share-based payments                |                                         
|                                                                      |                                                                                                                                                     | Non cash interest expense                    |                                         
|                                                                      |                                                                                                                                                     | Changes in operating assets and liabilities: |                                         
|                                                                      |                                                                                                                                                     |                                              | Accounts receivable                     
|                                                                      |                                                                                                                                                     |                                              | Inventory and other current assets      
|                                                                      |                                                                                                                                                     |                                              | Other assets                            
|                                                                      |                                                                                                                                                     |                                              | Accounts payable and accrued expenses   
|                                                                      |                                                                                                                                                     |                                              | Deferred revenue                        
|                                                                      |                                                                                                                                                     |                                              | Long-term interest and other liabilities
|                                                                      |                                                                                                                                                     |                                              |                                         
|                                                                      | Net cash used in operating activities:                                                                                                              |                                              |                                         
|                                                                      |                                                                                                                                                     |                                              |                                         
|Cash flows from investing activities:                                 |                                                                                                                                                     |                                              |                                         
|                                                                      | Purchases of property and equipment                                                                                                                 |                                              |                                         
|                                                                      | Proceeds from sale of short-term investments                                                                                                        |                                              |                                         
|                                                                      | Purchase of short-term investments                                                                                                                  |                                              |                                         
|                                                                      |                                                                                                                                                     |                                              |                                         
|                                                                      | Net cash provide by (used in) investing activities                                                                                                  |                                              |                                         
|                                                                      |                                                                                                                                                     |                                              |                                         
|Cash flows from financing activities:                                 |                                                                                                                                                     |                                              |                                         
|                                                                      | Principal payments on capital lease obligations and notes payable                                                                                   |                                              |                                         
|                                                                      | Restricted cash                                                                                                                                     |                                              |                                         
|                                                                      | Proceeds from convertible notes payable                                                                                                             |                                              |                                         
|                                                                      | Proceeds from the issuance of common and preferred stock, net of offering costs                                                                     |                                              |                                         
|                                                                      | Payment of debt financing costs                                                                                                                     |                                              |                                         
|                                                                      |                                                                                                                                                     |                                              |                                         
|                                                                      | Net cash provided by financing activities                                                                                                           |                                              |                                         
|                                                                      |                                                                                                                                                     |                                              |                                         
|Net increase in cash                                                  |                                                                                                                                                     |                                              | (10                                     
|Cash at beginning of year                                             |                                                                                                                                                     |                                              | 714                                     
|                                                                      |                                                                                                                                                     |                                              |                                         
|Cash at end of year                                                   |                                                                                                                                                     | $                                            | 704                                     
|                                                                      |                                                                                                                                                     |                                              |                                         
|Supplemental disclosure of cash flows information:                    |                                                                                                                                                     |                                              |                                         
|                                                                      | Cash paid for interest                                                                                                                              |                                              | $                                       
|                                                                      | Cash paid for taxes                                                                                                                                 |                                              |                                         
|Supplemental schedule of non cash investing and financing activities: |                                                                                                                                                     |                                              |                                         
|                                                                      | Conversion of notes payable to common stock                                                                                                         |                                              |                                         
|                                                                      | Conversion of related parties notes payable to Series D Mandatorily Redeemable Convertible Preferred Stock                                          |                                              |                                         
|                                                                      | Conversion of accrued interest into common stock                                                                                                    |                                              |                                         
|                                                                      | Conversion of related party convertible notes payable accrued interest and premium into Series D Mandatorily Redeemable Convertible Preferred Stock |                                              |                                         
|                                                                      | Common stock issued to directors for services rendered                                                                                              |                                              |                                         
|                                                                      | Share-based paymentrelated party for financing services                                                                                            |                                              |                                         
|                                                                      | Redemption premium on Series D Mandatorily Redeemable Convertible Preferred Stock                                                                   |                                              |                                         

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

73

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OSIRIS THERAPEUTICS, INC.        NOTES TO FINANCIAL STATEMENTS        YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005        (amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies

Description of Business

Osiris Therapeutics, Inc. is a Delaware corporation headquartered in Columbia, Maryland. We began operations on December 23, 1992. The Company is a
clinical stage biotechnology company founded to commercialize stem cell products from adult bone marrow. We launched our first commercial product in July 2005. Our operations consist primarily of
research, development and clinical activities to bring our biologic drug candidates to the marketplace and efforts to secure adequate capital for anticipated growth and operations.

We
are dependent upon the registration of our core products for sale before we can expand our commercial operations. We expect to submit product applications for approval with the United
States Food and Drug Administration ("FDA") in the future and plan to continue to seek additional equity and debt financing as the need arises. We believe our long-term cash position is
inadequate to fund all of the costs associated with the full range of testing and clinical trials required by the FDA for our core products. We expect that our available cash and interest income,
including the availability under our line-of-credit, will be sufficient to finance currently planned activities through at least early 2009. We have several research
collaboration agreements and a government contract that provide us with funding.

No
assurance can be given that (i) we will be able to expand our operations prior to FDA approval of our biologic drug candidates, or (ii) that the FDA approval will ever
be granted for our biologic drug candidates.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and accompanying notes. Due to the inherent uncertainty involved in making those assumptions, actual results could differ from
those estimates. We believe that the most significant estimates that affect our financial statements are those that relate to inventory valuation, deferred tax assets, and share-based compensation.

Short-term Investments

Short-term investments consist primarily of investment grade auction rate certificates with maturities of less than three months.
Short-term investments are valued at cost, which approximates their fair value.

Accounts Receivable

Our accounts receivable are reported at their net realizable value. As of December 31, 2007 and 2006, there was no allowance for doubtful accounts as we
believe the reported amounts are fully collectible. During the year ended December 31, 2006, we recognized $3 of bad debt expense. We did not recognize any bad debts expense in 2007 or 2005.
Accounts receivable balances are not collateralized.

74

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OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies (Continued)

Inventory

We commenced sales of our first commercial product, Osteocel, in July 2005 and began carrying inventory on our balance sheet thereafter. Inventory consists of
tissue products in process and available for distribution. We determine our inventory values using the first-in, first-out method. Due to the nature of our Osteocel product, we
incur all of the costs to manufacture the product prior to completing the extensive testing and evaluation necessary to determine if the product can be released. We estimate the reserve for
work-in-process inventory based upon our historical experience. We have nominal amounts of finished goods inventory.

Inventory
of supplies purchased to manufacture of biologic drug candidates and manufactured biologic drug candidate doses are presently used exclusively for research and development
activities, including clinical trials. These items are expensed as incurred, consistent with our accounting for all other research and development costs.

Property and Equipment

We record property and equipment, including improvements that extend useful lives, at cost, while maintenance and repairs are charged to operations as incurred.
We calculate depreciation using the straight-line method based on estimated useful lives ranging from three to seven years for furniture, equipment and internal use software. We amortize
leasehold improvements and assets under capital leases over the shorter of the estimated useful life of the asset or the original term of the lease.

Valuation of Long-lived Assets

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of
assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future
cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows we expect the assets to
generate. We group assets at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the total of the expected
undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized for the difference between the fair value and carrying value of assets. Fair value is
generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. There were
no impairment losses recognized during the years 2007, 2006 or 2005.

Assets
to be disposed of are reported at the lower of carrying values or fair values, less estimated costs of disposal.

Deferred Financing Costs

We amortize the costs we incur to obtain debt financing over the terms of the underlying obligations using the effective interest method. The amortization of debt
financing costs is included in

75

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies (Continued)

interest
expense. In 2007, we induced the conversion of $18.8 million of our convertible promissory notes into common stock and accelerated the amortization of $352 of previously deferred
financing fees. In 2006, we refinanced a $20.6 million convertible promissory note to a foreign investor, and we converted $21.8 million of convertible debt into common stock concurrent
with our initial public offering. In connection with these transactions, in 2006, we recognized $2.1 million in interest expense for the deferred costs associated with these instruments, which
were paid off. In 2005, we recognized $476 in interest expense from the amortization of these costs.

Revenue Recognition

Our revenue recognition policies are in accordance with the Securities and Exchange Commission's (SEC) Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements, as amended by SEC Staff Accounting Bulletin No. 104,Revenue
Recognition.

In
July 2005, we launched our first commercial product, Osteocel. We recognize revenue on Osteocel sales when legal title to the product has passed to the customer, which is generally
when the product is shipped from our Baltimore, Maryland facilities. We have agreements with our customers that specify the terms of sale, including price. During 2007 and 2006, sales of our Osteocel
product were primarily to two customers. We have entered into several strategic agreements with other pharmaceutical companies focusing on the development and commercialization of our stem cell drug
products. In 2003, we entered into such an agreement with Boston Scientific Corporation pertaining to our cardiac drug development and we received a $5 million fee for licensing the use of our
technology. We terminated the agreement with Boston Scientific Corporation in 2007 and recognized the remaining unamortized license fee of $1.3 million. We recognized $952 of license fee
revenue in 2006 and 2005. Also in 2003, we entered into a similar agreement with JCR Pharmaceuticals Co., Ltd. ("JCR") pertaining to our hematologic malignancies drugs for distribution
in Japan. We recognized $500 of revenue in 2007 and $500 in 2005 from JCR upon the achievement of milestone events specified in the agreement.

Revenues
from collaborative research licenses and grants are recognized as earned upon either the incurring of reimbursable expenses directly related to the particular research plan or
the completion of certain development milestones as defined within the terms of the collaborative agreement. Payments received in advance of research performed are designated as deferred revenue. We
recognize non-refundable upfront license fees and certain other related fees on a straight-line basis over the development period. Fees associated with substantive at risk,
performance based milestones are recognized as revenue upon their completion, as defined in the respective agreements. Incidental assignment of technology rights is recognized as revenue as earned and
was received from an unrelated third party.

Historically,
we have also recognized revenue from governmental grants for research products and in 2005 we recorded $1.4 million in grant revenue as we completed work on three
separate grants. Revenue from research grants is recognized as the related research expenditures are incurred. We no longer solicit governmental grants, and did not recognize any revenue from grants
during 2007 or 2006.

76

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies (Continued)

Cost of Goods Sold

Costs of goods sold of Osteocel consist primarily of the costs to obtain the tissue and other chemicals and supplies, quality and sterility testing, plus labor
and allocated overhead costs and the costs of operating the clean-room facilities.

Research and Development Costs

Research and development costs are expensed as incurred.

Income Taxes

Deferred tax liabilities and assets are recognized for the estimated future tax consequences of temporary differences, income tax credits and net operating loss
carry-forwards. Temporary differences are primarily the result of the differences between the tax bases of assets and liabilities and their financial reporting values. Deferred tax liabilities and
assets are measured by applying the enacted statutory tax rates applicable to the future years in which deferred tax liabilities or assets are expected to be settled or realized. Valuation allowances
are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense, if any, consists of the taxes payable for the current period and the change
during the period in deferred tax assets and liabilities. For all periods presented, valuation allowances have been provided for the full amount of net deferred tax assets and no income tax expense or
benefit has been recognized.

Comprehensive Income

In 2007, 2006 and 2005, except for our net loss, we did not have any components of comprehensive income as defined in the accounting literature.

Loss per Common Share

Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted loss per
common share adjusts basic loss per share for the potentially dilutive effects of shares issuable under our stock option plans, and the conversion of our preferred stock and convertible debt, using
the treasury stock method. Common equivalent shares from the conversion of preferred stock and convertible debt and the exercise of stock options and warrants are excluded from the computation of
diluted loss per share as their effect is anti-dilutive. Since our initial public offering in August 2006, the market value of our common stock is determined based upon the closing price
on the NASDAQ Global Market. Prior to August 2006 when our common stock started publicly trading, our Board of Directors determined the fair value of our common stock.

Share-Based Compensation

In December 2004, the Financial Accounting Standards Board, ("FASB") issued Statement No. 123(R), "Share-Based
Payment," which is a revision of Statement No. 123, "Accounting for Stock

77

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies (Continued)

Issued to Employees." Effective January 1, 2006, we adopted Statement No. 123(R) using the modified prospective method under which prior period amounts are not
restated for comparative purposes. Under the modified prospective method, we are required to recognize compensation cost:



Under
Statement No. 123(R), we are required to recognize all share-based payments to employees and non-employee directors in our financial statements based on their
grant date fair values, using prescribed option-pricing models. We use the Black-Scholes option pricing model to value share-based payments. Compensation expense related to share-based awards is
recognized on a straight-line basis based on the value of share awards that are scheduled to vest during the requisite service period. Under Statement No. 123(R), share-based
compensation expense is based on awards ultimately expected to vest and must be reduced for estimated forfeitures.

Upon
adoption of Statement No. 123(R), we reclassified our unamortized unearned compensation related to option awards to additional paid-in capital in our balance
sheet.

Concentration of Risk

We maintain cash and short-term investment balances in accounts that exceed federally insured limits, although we have not experienced any losses on
such accounts. We invest our excess cash in investment grade securities, generally with maturities of three months or less. We provide credit, in the normal course of business, to the distributors of
our product. Our receivables at December 31, 2007 consist primarily of amounts due from four commercial customers, and we expect these receivables to be collected.

Significant New Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards ("SFAS") 157,"Fair Value
Measurements."SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about
fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. We do not expect
the implementation of SFAS 157 to have a material impact on our financial statements.

In
June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48").
FIN 48 clarifies when tax benefits should be recorded in financial statements, requires certain disclosures of uncertain tax matters and indicates how any tax reserves should be classified in a
balance sheet. On January 1, 2007, the Company adopted FIN 48. We have determined that adoption of FIN 48 did not have any impact on our financial condition or results of
operations. It
is our policy to recognize interest and penalties related to unrecognized tax liabilities within income tax expense in the statements of operations.

78

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies (Continued)

In
February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial Assets and Liabilities." SFAS 159 permits
entities to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility
in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This pronouncement is effective as of the beginning of
an entity's first fiscal year beginning after November 15, 2007. We do not expect the implementation of SFAS 159 to have a material impact on our financial position or results of
operations.

In
June 2007, the FASB ratified a consensus opinion reached by the Emerging Issues Task Force ("EITF") on EITF Issue 07-3,"Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities."The guidance in EITF Issue 07-3 requires us to
defer and capitalize nonrefundable advance payments made for goods or services to be used in research and development activities until the goods have been delivered or the related services have been
performed. If the goods are no longer expected to be delivered nor the services expected to be performed, we would be required to expense the related capitalized advance payments. The consensus in
EITF Issue 07-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2007 and is to be applied prospectively to new contracts
entered into on or after December 15, 2007. Early adoption is not permitted. Retrospective application of EITF Issue 07-3 is also not permitted. We intend to adopt EITF Issue
07-3 effective January 1, 2008. The impact of applying this consensus will depend on the terms of the our future research and development contractual arrangements entered into on or
after December 15, 2007.

In
December 2007, the FASB ratified a consensus reached by the EITF on Issue 07-1, "Accounting for Collaborative
Arrangements."The EITF concluded on the definition of a collaborative arrangement and that revenues and costs incurred with third parties in connection with collaborative
arrangements would be presented gross or net based on the criteria in EITF 99-19 and other accounting literature. Based on the nature of the arrangement, payments to or from
collaborators would be evaluated and its terms, the nature of the entity's business, and whether those payments are within the scope of other accounting literature would be presented. Companies are
also required to disclose the nature and purpose of collaborative arrangements along with the accounting policies and the classification and amounts of significant financial-statement amounts related
to the arrangements. Activities in the arrangement conducted in a separate legal entity should be accounted for under other accounting literature; however required disclosure under
EITF 07-1 applies to the entire collaborative agreement. EITF 07-1 is effective for us January 1, 2008 and is to be applied retrospectively to all periods
presented for all collaborative arrangements existing as of the effective date. We do not expect the adoption of EITF 07-1 to have a material impact on our financial statements.

In
December 2007, the FASB issued SFAS 141, Revised 2007 (SFAS 141R),"Business Combinations."SFAS 141R's objective
is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects.
SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after December 15, 2008. We do not expect the implementation of SFAS 141R to have
a material impact on our financial statements.

79

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

1. Description of Business and Significant Accounting Policies (Continued)

In
December 2007, the FASB issued SFAS 160,"Noncontrolling Interests in Consolidated Financial Statements."SFAS 160's
objective is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting
and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 shall be effective for fiscal years and interim periods within
those fiscal years, beginning on or after December 15, 2008. We do not expect the implementation of SFAS 160 to have a material impact on our financial statements.

2. Initial Public Offering and Reverse Stock Split

On August 9, 2006, we consummated our initial public offering, consisting of 3,500,000 shares of common stock at a public offering price of $11.00,
resulting in net proceeds to us of approximately $34.4 million (after deducting payment of underwriters discounts and commissions, as well as offering expenses). Our common stock began trading
on the NASDAQ Global Market on August 4, 2006.

In
connection with the initial public offering, we effected a 1-for-4 reverse stock split of our issued and outstanding common stock. Information relating to our
common stock and common stock-equivalents set forth in this report has been restated to reflect this split for all periods presented. Upon consummation of the initial public offering, all outstanding
shares of the Class I, Series 2003, Series B, Series C, Series E and the Mandatorily Redeemable Series D convertible preferred stock were converted into an
aggregate of 10,867,302 shares of our common stock. In
addition, approximately $21.8 million of our convertible notes payable, together with accrued interest, were converted into an aggregate of 2,774,076 shares of our common stock.

Immediately
following the initial public offering, we had 27,198,307 shares of common stock outstanding.

We
incurred $7.0 million in non-cash charges relating to the completion of the initial public offering. Included in General and Administrative expenses in 2006 are a
non-cash charge of $0.8 million for stock-based compensation related to the accelerated vesting of certain employee stock options pursuant to employment agreements. We also
recognized a $3.5 million share-based payment to related party related to warrants that were priced upon the completion of the initial public offering and $0.2 million in share-based
compensation for stock awarded to our directors for service on our board. Interest expense includes $2.7 million in previously deferred financing costs and premiums that were expensed as a
result of debt that was converted into common stock at the completion of the initial public offering.

80

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

3. Property and Equipment

Property and equipment consist of the following at December 31,

2007

2006Laboratory and manufacturing equipment

$
5,612

$
4,720Computer hardware, furniture and fixtures


1,402


1,213Leased assets


11,725


11,725Leasehold improvements


8,669


4,517Construction in process


14


54527,422


22,720Accumulated depreciation and amortization


(20,806
)

(18,778
)Property and equipment, net

$
6,616

$
3,942


4. Notes Payable and Capital Lease Obligations

December 31,2007

2006Bank Loan, payable in quarterly installments and bearing interest at LIBOR plus applicable margins, 7.33%7.83% in 2006

$


$
49Boston Scientific Corporation Term Note, 8%, due quarterly through January 2009


6,521


5,000Term Notes, 10%, convertible into common stock at $18 per share and under specified conditions


1,200


20,0007,721


25,049Less current portion


(6,521
)

(49
)Notes payablelong-term

$
1,200

$
25,000Total capital lease obligations

$
897

$
2,024Less current portion


(886
)

(1,129
)Capital lease obligations, long-term

$
11

$
895


During
June 1995, we borrowed $750 from a commercial bank in connection with the acquisition and renovation of our Baltimore, Maryland facilities. This loan was partially
guaranteed by an agency of the State of Maryland and matured in September 2007. Prior to maturity, this loan accrued interest at LIBOR plus 2.0% to 2.5%. This loan was repaid upon maturity.

In
2004, we borrowed $5.0 million on the $50.0 million line-of-credit entered into with Boston Scientific Corporation which was part of a
collaborative arrangement for the development of our biologic drug candidate for cardiac indications. Under the terms of the original line-of-credit, this loan was to be repaid
from the proceeds of future sales. In December 2007, the collaborative agreement was terminated. The line-of-credit was cancelled and the outstanding principal, together with
accrued interest, was converted into a one-year term note, bearing interest at 8% and payable in quarterly installments starting in January 2008.

81

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

4. Notes Payable and Capital Lease Obligations (Continued)

In October 2006, we issued $20.0 million in convertible promissory notes in a private placement to several Swiss investors. The notes accrued interest at a
rate of 10%, with semi-annual payments of accrued interest becoming due and payable on April 30 and October 30 of each calendar year, until maturity on April 30, 2009.
The notes were convertible at the option of the respective holders at any time after February 9, 2007, into shares of common stock at the conversion price of $18.00 per share. The notes
initially provided for automatic conversion into common stock at the same conversion price, if at any time after February 9, 2007, the closing price of the our common stock on the NASDAQ Global
Market closed for ten consecutive trading days at $25.00 per share or greater. The notes also provided for redemption at any time at our option, with 30-day written notice.

In
December 2007, we reduced the conversion price of the 10% notes to $13.00 per share and induced the conversion of $18.8 million of the notes, together with accrued interest
into 1,465,837 shares of common stock. In connection with this induced conversion, we recorded a non-cash charge of $4.8 million as interest expense. In January 2008, we induced the
conversion the remaining $1.2 million of these notes, together with accrued interest into 85,714 shares of common stock at the conversion price of $14.00 per share, which resulted in a
non-cash charge of $248 as interest expense.

Future Maturities of Notes Payable and Capital Lease Obligations

For years subsequent to 2007, scheduled annual maturities of notes payable and capital lease obligations outstanding as of December 31, 2007, are as
follows:

Notes
Payable

Capital
Lease
Obligations

Total2008

$
6,521

$
886

$
7,4072009


1,200


7


1,2072010





4


4$
7,721

$
897

$
8,618


5. Preferred Stock Conversion

All our convertible preferred stock was converted into common stock upon the completion of our initial public offering in August 2006.

|                                                                                                                                      |  | No. Shares of Common Stock Issued Upon Conversion at IPO (Aggregate Liquidation Preference / Conversion Price) Per Share
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------
|Convertible preferred stock, Class I, Series 2003, $0.001 par value, 2,000,000 shares designated, issued and outstanding in 2005      |  | 500,000                                                                                                                 
|Convertible preferred stock, Series B, $0.001 par value, 750,000 shares designated, 545,454 shares issued and outstanding in 2005     |  | 136,364                                                                                                                 
|Convertible preferred stock, Series C, $0.001 par value, 3,500,000 shares designated, 548,090 shares issued and outstanding in 2005   |  | 308,300                                                                                                                 
|Convertible preferred stock, Series E, $0.001 par value, 8,000,000 shares designated, 7,557,000 shares issued and outstanding in 2005 |  | 1,889,250                                                                                                               
|                                                                                                                                      |  |                                                                                                                         
|                                                                                                                                      |  | 2,833,914                                                                                                               
|                                                                                                                                      |  |                                                                                                                         

82

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

5. Preferred Stock Conversion (Continued)

We
issued 2,000,000 shares of our Class I, Series 2003 convertible preferred stock to a collaborative partner as part of an agreement related to product
development, clinical trials and FDA approval. These shares were converted into 500,000 shares of our common stock at the conversion price of $20.00 per share.

We
issued 545,454 shares of our Series B convertible preferred stock in 2003, as part of a collaborative agreement. These shares were converted into 136,364 shares of our common
stock at the conversion price of $22.00 per share.

We
issued 548,090 shares of our Series C convertible preferred stock in 2004 at the price of $4.50 per share. These shares were converted into 308,300 shares of our common stock
at the conversion price of $8.00 per share.

We
issued 7,557,000 shares of our Series E convertible preferred stock in 2005 at a price of $2.50 per share. These shares were converted into 1,889,250 shares of our common stock
at the conversion price of $10.00 per share.

Also
in 2005, we issued 3,213,335 shares of Series D Mandatorily Redeemable Convertible Preferred Stock at a price of $2.00 per share. These shares were converted into 8,033,388
shares of our common stock at the conversion price of $0.80 per share.

These
Series D shares included a mandatory redemption feature whereby if we did not complete an initial public offering prior to June 1, 2007 and the shares were not
previously converted into common stock, we would be required to redeem the shares at a price of $20.00 per share. The Series D Mandatorily Redeemable Convertible Preferred Stock was recorded as
a liability in the balance sheet at December 31, 2005, in accordance with SFAS No. 150 "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity." In addition to the initial net proceeds of $6.0 million from the Series D offering, a redemption premium of $58.3 million was
recorded as a liability.

6. Share-Based Compensation

In April 2006, we adopted our 2006 Omnibus Plan. In addition, we had previously established our Amended and Restated 1994 Stock Incentive Plan. Both Plans
authorize the issuance of various forms of stock-based awards, including incentive and non-qualified stock options, stock purchase rights, stock appreciation rights and restricted and
unrestricted stock awards. A total of 850,000 shares of our common stock have been reserved for issuance under the 2006 Omnibus Plan, and 736,378 shares were reserved under our Amended and Restated
1994 Stock Incentive Plan. We ceased all grants under the Amended and Restated 1994 Stock Incentive Plan concurrent with our initial public offering in August 2006. As a result, no shares are
currently available for future awards under the Amended and Restated 1994 Stock Incentive Plan. At December 31, 2007, there were 426,260 shares available for future awards under the 2006
Omnibus Plan.

We
generally issue stock option awards that vest over four years and have a ten-year life. We estimate the fair value of stock options using the Black-Scholes option-pricing
model. Our common stock started trading on the public market in August 2006, and the historical data to determine volatility does not presently exist. We determine volatility by using the historical
stock volatility of other

83

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

6. Share-Based Compensation (Continued)

companies
with similar characteristics. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

The
fair value of stock options granted during each of the periods was estimated using the following assumptions:

|                                                 |  | Years ended December 31, |  
|------------------------------------------------ |  | ------------------------ | -
|
|Assumptions                                      |  |                          |  
|Weighted average risk-free interest rate         |  | 4.61                     | %
|Dividend yield                                   |  | 0.0                      | %
|Expected life of option grants                   |  | 4.5-years                |  
|Weighted average expected stock price volatility |  | 67.07                    | %

A
summary of stock option activity for the years ended December 31, 2007, 2006 and 2005 is as follows:

|                                 |                       | Number of
Shares |          | Weighted
Average
Exercise
Price |      | Weighted
Average
Remaining
Contractual Life |           | Aggregate
Intrinsic Value
(in thousands)
|-------------------------------- | --------------------- | ---------------- | -------- | ------------------------------- | ---- | ------------------------------------------- | --------- | ----------------------------------------
|Outstanding at January 1, 2005   |                       | 543,652          |          | $                               | 0.70 |                                             | 7.9-years |                                         
|                                 | Granted               |                  | 106,000  |                                 | $    | 0.40                                        |           |                                         
|                                 | Exercised             |                  | (27,148  | )                               | $    | (0.41                                       | )         |                                         
|                                 | Forfeited or canceled |                  | (56,024  | )                               | $    | (3.45                                       | )         |                                         
|                                 |                       |                  |          |                                 |      |                                             |           |                                         
|Outstanding at December 31, 2005 |                       | 566,480          |          | $                               | 0.40 |                                             | 8.4-years |                                         
|                                 | Granted               |                  | 314,500  |                                 | $    | 4.06                                        |           |                                         
|                                 | Exercised             |                  | (178,378 | )                               | $    | (0.41                                       | )         |                                         
|                                 | Forfeited or canceled |                  | (6,687   | )                               | $    | (1.36                                       | )         |                                         
|                                 |                       |                  |          |                                 |      |                                             |           |                                         
|Balance, December 31, 2006       |                       | 695,915          |          | $                               | 2.05 |                                             | 8.3-years |                                         
|                                 | Granted               |                  | 373,500  |                                 | $    | 18.30                                       |           |                                         
|                                 | Exercised             |                  | (141,312 | )                               | $    | (0.42                                       | )         |                                         
|                                 | Forfeited or canceled |                  | (47,693  | )                               | $    | (12.49                                      | )         |                                         
|                                 |                       |                  |          |                                 |      |                                             |           |                                         
|Balance, December 31, 2007       |                       | 880,410          |          | $                               | 8.64 |                                             | 8.3-years |                                         
|                                 |                       |                  |          |                                 |      |                                             |           |                                         
|Exercisable at December 31, 2007 |                       | 353,961          |          | $                               | 1.18 |                                             | 7.2-years |                                         
|                                 |                       |                  |          |                                 |      |                                             |           |                                         

84

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

6. Share-Based Compensation (Continued)

A
summary of stock options outstanding at December 31, 2007, by price range is as follows:

|                   |  | Options Outstanding |  | Options Exercisable
|------------------ |  | ------------------- |  | -------------------
|
|$  0.40 to $  0.79 |  | 367,315             |  | 7.2                
|0.80 to    2.00    |  | 1,282               |  | 5.7                
|2.01 to  10.00     |  | 152,563             |  | 8.5                
|10.01 to  15.00    |  | 190,250             |  | 9.5                
|15.01 to  20.00    |  | 1,500               |  | 9.1                
|$20.01 to $28.56   |  | 167,500             |  | 9.1                
|                   |  |                     |  |                    
|                   |  | 880,410             |  | 8.3                
|                   |  |                     |  |                    

The
weighted fair value of options granted during the years ended December 31, 2007, 2006 and 2005 were $10.61, $7.11 and $2.84, respectively.

Both
contemporaneous and retrospective valuations were performed by our Board of Directors for options granted from January 2005 through the date of our initial public offering. As a
result of these valuations, we, for financial reporting purposes, retrospectively adjusted the fair market value of the equity instruments granted during certain periods.

During
2003, we cancelled and reissued 126,366 stock options that had previously been granted at amounts equal to the estimated fair value of the underlying stock. The exercise price of
the reissued stock options was reduced to $0.40 per share at a time when the estimated fair value of the common stock was $6.00 per share. We are accounting for these options as if they were simply
repriced. As such, we accounted for these repriced options using variable accounting under FASB Interpretation No. 44.Accounting for Certain Transactions Involving
Stock Compensation (an Interpretation of APB No. 25)Consequently, during each reporting period we record compensation expense relating to the vested portion of the repriced options to the extent that the fair market value of our common stock exceeds
the exercise price of such options. Compensation expense of $0, $530 and $35 was recognized during the years ended December 31, 2007, 2006 and 2005, respectively.

In
connection with the stock options exercised during the year ended December 31, 2007, we received cash proceeds of $60. At December 31, 2007, there was
$3.2 million of total unrecognized compensation costs related to non-vested stock options, which is expected to be recognized over a weighted average period of three years.

The
table below reflects the total share-based compensation expense recognized in our income statements for the years ended December 31, 2007, 2006 and 2005. FASB Statement
No. 123(R) requires forfeitures to be estimated at the time an award is granted and revised, if necessary, in subsequent periods if factual forfeitures differ from those estimates.
Pre-vesting forfeitures were estimated to be between 0% and 20% based on historical experience. For the years ended December 31, 2007 and 2006, share-based compensation expense is
based on awards ultimately

85

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

6. Share-Based Compensation (Continued)

expected
to vest and has been reduced for estimated forfeitures. In our pro forma disclosures of share-based compensation under FASB Statement No. 123, we accounted for forfeitures as they
occurred.

Year ended December 31,2007

2006

2005Cost of goods sold

$
30

$


$
Research and development


608


755


General and administrative


702


4,738


109Share-based compensation

$
1,340

$
5,493

$
109


As
permitted by Statement No. 123, prior to January 1, 2006, we accounted for share-based payments to employees using the intrinsic value method prescribed by Accounting
Principles Board (APB) Opinion No. 25. Under APB Opinion No. 25, we recorded compensation expense over the vesting period to the extent that the fair value of the underlying shares of
common stock on the grant date exceeded the exercise or acquisition price of the share-based award. Primarily because options granted under our share-based incentive compensation plans had an exercise
price equal to the market value of the underlying common stock on the grant date, we generally did not recognize compensation cost related to employee stock options. For the year ended
December 31, 2005, the following table illustrates the effect on net income and earnings per share if we had determined compensation cost by applying the fair value recognition provisions of
Statement No. 123 to share-based employee awards.

2005Net loss, as reported

$
(19,995
)Add stock-based employee compensation included in reported net loss


109Deduct total stock-based employee compensation determined under fair-value-based method for all awards


(8
)Pro forma net loss

$
(19,894
)Basic and diluted loss per share, as reported

$
(2.23
)Basic and diluted loss per share, pro forma

$
(2.23
)


7. Related Party Transactions

General.Peter Friedli, the Chairman of our Board of Directors, or entities with which he is
affiliated, have been responsible for procuring since 1993, an aggregate of approximately $250 million in debt and equity financing for us and our predecessor company. Mr. Friedli is the
beneficial owner of more than 48% of our common stock as of December 31, 2007. Of the shares beneficially owned by Mr. Friedli, 25,000 shares were received by him as Board compensation
since 1996, 12,500 shares were granted in recognition of his fundraising efforts, as discussed below, and the remaining shares were acquired through investment or purchase from third parties.

86

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

7. Related Party Transactions (Continued)

Consulting Agreement.Beginning in 1995, we and our predecessor company were party to a Consulting
Agreement, originally with Friedli Corporate Finance AG, and subsequently Friedli Corporate Finance, Inc., or FCF, for the provision of business and advisory services to us. Mr. Friedli
is the sole owner of FCF. Under this agreement, FCF provided general business, financial and investment advice to us, and served as a liaison between us and FCF clients who have invested in us, many
of which are located in Switzerland. The Consulting Agreement between us and FCF was terminated upon the closing of our initial public offering in August 2006. The base compensation paid by us under
this agreement was $47 in 2006 and $65 in 2005. In addition, pursuant to this Consulting Agreement, we paid $50 as expense reimbursements in 2005 and $350 in 2006, to or as directed by FCF. No fees
were paid to Mr. Friedli or FCF during 2007.

Private Placements.Separate from the Consulting Agreement, FCF served as our agent in Europe in
connection with:



Mr. Friedli
also arranged the placement through a European investment bank of a $20.6 million convertible promissory note in late fall 2005. In connection with all of these
transactions, an aggregate of $103.7 million in gross proceeds was raised for us.

In
October 2007, we also obtained a $30.0 million financing commitment from FCF. This financing commitment is for a twelve month term and provides for financing through the
issuance by us of common stock at a price determined as the basis of market value, or the issuance by us of three-year promissory notes bearing interest at LIBOR plus 4%. Although we
control the timing of any draws made during the term of the commitment, FCF determines the identity of the purchasers and whether we issue common stock or promissory notes, subject, however to
limitations on, among other things, the

87

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

7. Related Party Transactions (Continued)

aggregate
number of shares of common stock that may be issued. We did not incur any fees in connection with the establishment of this financing commitment.

We
did not pay any fees for any of the financings arranged in 2007 through Mr. Friedli or entities with which he is affiliated.

Prior
to 2007, we paid referral fees and costs of $3.4 million to accounts designated by Mr. Friedli, including accounts of unrelated third parties. Also prior to 2007, we
paid expense reimbursement of $350 to Mr. Friedli and issued 12,500 shares of our common stock to him in recognition of his fundraising efforts on our behalf in 2004 and 2005. In addition,
specific to the placement of the $20.6 million convertible promissory note in late fall 2005, we paid placement agency fees to the European investment bank.

In
addition, we paid $600 to Friedli Corporate Finance, Inc. in connection with the issuance of the $20.0 million in Convertible Notes in 2006. Included among the
purchasers was Mr. Friedli, individually, who purchased $4,500,000, and New Venturetec, Inc., a Swiss publicly traded company approximately 3% owned by Mr. Friedli who serves as
its President, which purchased an additional $4,000,000 of the Convertible Notes. The $4,000,000 in Convertible Notes originally purchased by New Venturetec, Inc. were subsequently acquired by
Mr. Friedli from New Venturetec in a separate transaction. Our Board of Directors, including all of our independent directors, but with Mr. Friedli abstaining, together with the audit
committee, unanimously approved the offering and sale of the Convertible Notes, including the sales to Mr. Friedli and New Venturetec, Inc. and the arrangements with Friedli Corporate
Finance, Inc.

New Venturetec/Pine Loans.In 2004, we obtained $2.35 million in debt financing through two
entities with which Mr. Friedli is affiliated. The first of these entities was, Venturetec, Inc., a wholly owned subsidiary of New Venturetec, Inc. The other entity is
Pine, Inc., a company which at the time of the financing was majority owned and managed by Mr. Friedli. These convertible demand notes accrued interest at 10% and included a 10% premium
due upon redemption.

In
this financing, Venturetec, Inc. lent us $1.35 million, and Pine lent us $1.0 million. In consideration of these loans, we issued to the lenders promissory notes
in the principal amount of the sums lent to us. We also issued warrants to Venturetec, Inc. for 237,500 shares of our common stock at $0.40 per share. These warrants were exercised concurrent
with our initial public offering.

To
facilitate these borrowings and other financings, and for commitments of consideration in respect of yet additional financing if needed, we issued warrants for an aggregate of
1,250,000 shares at an exercise price of $0.40 per share. Mr. Friedli subsequently arranged for the acquisition of those warrants and they have since been cancelled. In recognition of his
efforts in procuring the cancellation of all of these warrants, we issued a new warrant to Mr. Friedli, exercisable for up to 1,000,000 shares of our common stock at $11.00 per share, the price
for which shares were sold in the initial public offering. This warrant expires in May 2011.

88

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OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

7. Related Party Transactions (Continued)

Other Financings.We have engaged in the following additional financings that involved
Mr. Friedli, or entities with which he is affiliated:



Lockup Agreement.On October 30, 2006, we entered into a Lockup Agreement with
Mr. Friedli, Venturetec, Inc. and U.S. Venture 05, Inc. Pursuant to the Lockup Agreement, Mr. Friedli and such entities initially agreed with us, subject to limited
exceptions, not to transfer our securities held by them without our approval, until January 30, 2008. The Lockup Agreement was amended in September 2007, by an Amendment to Lockup Agreement,
pursuant to which Mr. Friedli and Venturetec. Inc have agreed to extend the term of the Lockup Agreement as applicable to them, until January 30, 2009.

89

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OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

8. Warrants

At December 31, 2007, we had warrants to purchase our common stock outstanding as shown in the following table.

Common Stock# of
Shares

Weighted
Average PriceWarrants outstanding, January 1, 2006

2,125,000

$
0.40Warrants granted

1,000000


11.00Warrants exercised

(875,000
)

0.40Warrants cancelled

(1,250,000
)

0.40Warrants outstanding, December 31, 2006

1,000,000

$
11.00Warrants granted




Warrants cancelled




Warrants exercised




Warrants outstanding, December 31, 2007

1,000,000

$
11.00


Following
is the summary of the status of outstanding warrants to purchase our common stock at December 31, 2007.

Warrant Price

Common Shares

Weighted Average
Remaining
Contractual Life

Intrinsic Value$11.00

1,000,000

3.5 years

$
1,000


In
August 2006, when the price of the 2006 warrant was determined, we computed its value using the Black-Scholes option pricing method, using a risk free interest rate of 4.80%, the
expected life of 2.5-years and a stock volatility factor of 44.66%. Since the Company just recently completed its initial public offering and previously its stock did not trade, we
determined the volatility by selecting a comparable public company in the biotech industry and tracking its stock prices over the past 2.5-years. The value of this warrant was determined
to be $3.5 million which as been recorded in the accompanying statement of operations as General and Administrative expenses during the year ended December 31, 2006.

90

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OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

9. Income Taxes

The components of the Company's net deferred tax assets at December 31 are as follows:

2007

2006Deferred Tax Assets:Net operating loss carry-forwards

$
85,016

$
63,157Research and experimentation credit carry-forwards


7,167


5,142Property and equipment


1,432


1,546Other





5193,615


69,896Valuation allowance


(93,615
)

(69,896
)Net deferred tax assets

$


$



Our
deferred tax assets have been fully reserved in both 2007 and 2006 since their ultimate future realization cannot be assured. The valuation allowance increased by
$23.7 million for the year ended December 31, 2007. We presently have available for federal income tax purposes, approximately $215 million of net operating loss carry-forwards
and $7.1 million of research and experimentation credit carry-forwards, which expire beginning in 2009 through 2027. However, as a result of changes in our ownership since inception, the amount
of these carry-forwards available to offset future taxable income and income taxes could be subject to annual limitations under IRC Section 382.

10. Research Collaboration Agreements and Government Contract

United States Department of Defense Contract.In January 2008, we were awarded a contract from the
United States Department of Defense ("DoD") to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from radiation exposure. Under the terms of the contract, the DoD
will provide funding to us for the development of Prochymal for acute radiation syndrome ("ARS") in two stages, with an initial amount of $4.2 million in 2008. If we are successful in obtaining
FDA approval for ARS, the contract provides for the purchase of up to 20,000 doses, at $10,000 per dose, of Prochymal in four 5,000 dose increments.

Genzyme Corporation Agreement.In 2007, we entered into a collaborative agreement with Genzyme
Corporation ("Genzyme") for the preparation and execution of development and purchase agreements made with U.S. and Allied governmental agencies. We will contribute Prochymal and corresponding safety
and efficacy data to the effort and Genzyme will lend its vast product development and large-scale commercialization expertise. The agreement provides for Genzyme to receive a royalty of 15% on sales
of Prochymal, limited to those sales made under contract to U.S. or Allied governmental agencies for emergency preparedness. We did not recognize any revenue or expense related to this collaborative
agreement during 2007.

Juvenile Diabetes Research Foundation Agreement.In 2007, we entered into a collaborative agreement
with the Juvenile Diabetes Research Foundation ("JDRF") which provides for $4.0 million in funding to support the development of Prochymal as a treatment for the preservation of insulin
production in patients with newly diagnosed type 1 diabetes mellitus. We initiated a Phase II clinical

91

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OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

10. Research Collaboration Agreements and Government Contract (Continued)

trial
evaluating Prochymal as a treatment for type 1 diabetes in the fourth quarter of 2007. We expect to receive $2.0 million from JDRF during 2008 based upon the achievement of
clinical milestones and the remaining $2.0 million in 2009, however, there can be no assurance of achieving these future milestones.

JCR Pharmaceuticals Agreement.In 2003, we entered into a strategic alliance with JCR
Pharmaceuticals Co., Ltd. ("JCR"). Under the JCR agreement, we have granted JCR the exclusive right in Japan to use our technology in conjunction with the treatment of hematologic
malignancies using hematopoietic stem cell transplants. The JCR agreement entitles us to a licensing fee and to royalties on any resulting revenue. Upon commencement of the agreement, JCR purchased
545,454 shares of our Series B Convertible Preferred Stock for $3.0 million. These shares were converted into 136,363 shares of our common stock concurrent with our initial public
offering in August 2006. They also paid us a $3.0 million licensing fee, which was recognized as revenue in 2004 and 2003. In 2007 and 2005, upon the completion of certain milestones, we
received $500 in each of those years as additional licensing fees, which was recognized as revenue.

Boston Scientific Agreement.Also in 2003, we entered into a long-term collaboration
agreement with Boston Scientific Corporation ("BSC") focusing upon the development and commercialization of the use of mesenchymal stem cells technology to treat cardiovascular disease. The BSC
agreement paid us a licensing fee and provided for royalties on resulting revenue, and included both a BSC equity investment and significant BSC debt financing for the cardiovascular project.

We
received a $5.0 million licensing fee for the use of our technology by BSC. This revenue was being recognized as revenue over a 63-month period, $952 of which was
recognized in 2006 and 2005. In 2007, we recognized the remaining unamortized licensing fee of $1.3 million.

As
provided for in the agreement, BSC purchased 2 million shares of our Class 1, Series 2003 Convertible Preferred Stock for $10 million. These shares were
converted into 500,000 shares of common stock concurrent with our initial public offering in August 2006.

The
agreement provided for a $50.0 million line of credit with BSC. In March 2004, the Company drew $5 million under this line of credit, which was recorded as
long-term debt and accrued interest at 8%.

In
December 2007, we terminated the Agreement with BSC and regained the worldwide rights to cardiac indications. Upon termination, the line of credit was cancelled and the outstanding
borrowings together with accrued interest was converted into a one-year 8% promissory note which is payable in quarterly installments beginning in January 2008.

11. Defined Contribution Plan

We have a 401(k) plan that is available to all employees. Employee contributions are voluntary and are determined on an individual basis up to the amount
allowable under federal regulations. Employer contributions to the plan are at the discretion of the Board of Directors and vest over a seven year period beginning after the third year of eligibility.
No employer contributions have been made to date.

92

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OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

12. Commitments and Contingencies

During 2006, we entered into a sublease agreement for approximately 61,000 square feet of laboratory, production, warehouse and office space in Columbia,
Maryland. We have also entered into a direct lease with the owner of this facility that is effective upon the expiration of the sublease and expires in July 2016. This lease has two
five-year renewal options. We have an outstanding letter of credit of $130 that is used in lieu of a security deposit for this lease. The letter of credit is fully collateralized by
restricted cash.

We
also lease approximately 126,000 square feet of laboratory, production, warehouse and office space in Baltimore, Maryland under an amended lease agreement that expires in September
2008. We intend to vacate the Baltimore facility upon the expiration of this amended lease and consolidate our operations in our Columbia, Maryland facility. This lease was originally arranged by the
Maryland Economic Development Corporation and the City of Baltimore who arranged the financing of the building improvements. We have an outstanding letter of credit of $150 that is used as security
for this lease. The letter of credit is fully collateralized by restricted cash. We sublease a portion of the office and warehouse space to a third party on a month-to-month
basis and record the $10 monthly rent as a reduction of our facilities expense.

We
also have entered into various financing arrangements to lease laboratory and other equipment. The terms of these facilities and equipment leases are considered capitalized leases,
and the following amounts are included in our balance sheets at December 31, 2007 and 2006:

2007

2006Facilities leases

$
8,568

$
8,568Equipment leases


3,157


3,15711,725


11,725Lessaccumulated amortization


(11,098
)

(10,351
)Leased property and equipment, net

$
627

$
1,374


Future
minimum lease payments under these capitalized facilities and equipment arrangements are as follows:

Facilities

Equipment

Total2007

$
906

$
8

$
9142008





8


82009





3


3906


19


925Less interest


(26
)

(2
)

(28
)Present value of minimum lease payments


880


17


897Less long-term portion





(11
)

(11
)Capital lease obligations, current

$
880

$
6

$
886


93

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

12. Commitments and Contingencies (Continued)

The
future minimum lease payments due under the operating lease for our Columbia, Maryland facility are as follows:

Columbia Facility2008

$
8762009


9782010


1,0562011


1,0822012


1,1092013 - 2016


3,999$
9,100


Agreement.In 1994, we entered into a Technology Transfer and License Agreement with Case Western
Reserve University ("CWRU") under which we purchased rights to certain mesenchymal stem cell and related technology and patents. We are required to pay royalties on revenues related to CWRU developed
technology, with minimum royalties of $50 per year. We paid CWRU $50 in 2007, 2006 and 2005.

13. Segment Reporting

In 2007, we began to manage our business in two reportable operating segments: the Biologic Drug Candidates segment and the Biologic Tissue Product segment. Our
Biologic Drug Candidates segment focuses on developing and marketing products to treat medical conditions in the inflammatory, orthopedic and cardiovascular areas. Its operations have focused on
clinical trials and discovery efforts to identify additional medical indications. Our Biologic Drug Candidates segment does not presently have any products approved for sale and its revenues consist
of license fees and royalties from collaborative research agreements.

Our
Biologic Tissue Product segment includes the manufacture and sale of Osteocel, which we launched in July 2005 and is currently being used by orthopedic surgeons for focal bone
repair.

We
evaluate the performance of our Biologic Tissue Product segment based upon gross margin and operating income before net interest expense, depreciation, and corporate general and
administrative expenses, which we refer to as segment profit or loss. We have presented estimated 2006 segment results through the gross profit result to compare to our 2007 presentation in the table
below. However, because our Biologic Tissue Product segment was not managed as a separate segment prior to 2007, we are unable to determine the other operating expenses that may have been attributable
to this segment in 2006 and 2005.

In
general, our total assets, including long-lived assets such as property and equipment, and our capital expenditures are not specifically allocated to any particular
operating segment. Accordingly, capital expenditures and total asset information by reportable segment is not presented. The reportable

94

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

13. Segment Reporting (Continued)

segments
use the same accounting policies as those used by the Company. There are no significant inter-segment sales or transfers.

Substantially
all of our revenues and assets are attributed to and are received from entities located in the United States. During the years ended December 31, 2007, 2006 and
2005, we sold product produced in our Biologic Tissue Product segment primarily to two customers, both of which represent greater than ten percent of our revenues.

The
table below sets forth the revenues, gross margin and segment profit (loss) for the year ended December 31, 2007, and the revenues and gross margin for the years ended
December 31, 2006 and 2005.

|                              |                                 | Biologic Drug Candidates |   | Biologic Tissue Product |   | Corporate |        | Total |  
|----------------------------- | ------------------------------- | ------------------------ | - | ----------------------- | - | --------- | ------ | ----- | -
|Year Ending December 31, 2007 |                                 |                          |   |                         |   |           |        |       |  
|                              | Revenues                        |                          | $ | 2,048                   |   | $         | 15,240 |       | $
|                              | Gross margin                    |                          |   |                        |   |           | 8,285  |       |  
|                              | Segment profit (loss)unaudited |                          |   | (45,092                 | ) |           | 4,574  |       |  
|Year Ended December 31, 2006  |                                 |                          |   |                         |   |           |        |       |  
|                              | Revenues                        |                          | $ | 1,181                   |   | $         | 8,291  |       | $
|                              | Gross margin                    |                          |   |                        |   |           | 4,594  |       |  
|Year Ended December 31, 2005  |                                 |                          |   |                         |   |           |        |       |  
|                              | Revenues                        |                          | $ | 3,013                   |   | $         | 957    |       | $
|                              | Gross margin                    |                          |   |                        |   |           | 513    |       |  

We
reported a loss in our Biologic Tissue Product segment for the quarter ending March 31, 2007 which was primarily attributable to costs associated with the expansion of our
Osteocel manufacturing facility, as we experienced failed production qualification runs while expanding our capacity. The production issues were subsequently resolved in late March 2007, and the
expanded facility has produced product in line with our expectations during the remainder of 2007. During the second quarter of 2008, we expect to start production of Osteocel in our Columbia,
Maryland facility and by the end of the third quarter of 2008, move all of our production activities to Columbia, Maryland

95

---



OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

(amounts in thousands, except for share and per share data)

14. Quarterly Financial Data (Unaudited)

Following is a summary of our Unaudited quarterly results for the years ended December 31, 2007, 2006 and 2005:

|                                               |                                              | First Quarter |       | Second Quarter |   | Third Quarter |         | Fourth Quarter |      
|---------------------------------------------- | -------------------------------------------- | ------------- | ----- | -------------- | - | ------------- | ------- | -------------- | -----
|2007                                           |                                              |               |       |                |   |               |         |                |      
|                                               | Total revenues                               |               | $     | 2,279          |   | $             | 3,547   |                | $    
|                                               | Product sales                                |               |       | 2,000          |   |               | 3,252   |                |      
|                                               | Cost of goods sold                           |               |       | 901            |   |               | 1503    |                |      
|                                               | Research and development expenses            |               |       | 11,030         |   |               | 10,583  |                |      
|                                               | General and administrative expenses and fees |               |       | 1,506          |   |               | 1,501   |                |      
|                                               | Net loss                                     |               |       | (11,501        | ) |               | (10,458 | )              |      
|**Net loss per common share, basic and diluted |                                              |               | (0.42 | )              |   | (0.37         | )       |                | (0.36
|2006                                           |                                              |               |       |                |   |               |         |                |      
|                                               | Total revenues                               |               | $     | 1,400          |   | $             | 1,987   |                | $    
|                                               | Product sales                                |               |       | 1,105          |   |               | 1,689   |                |      
|                                               | Cost of goods sold                           |               |       | 489            |   |               | 762     |                |      
|                                               | Research and development expenses            |               |       | 4,368          |   |               | 10,922  |                |      
|                                               | General and administrative expenses and fees |               |       | 1,138          |   |               | 1,209   |                |      
|                                               | Net loss                                     |               |       | (5,121         | ) |               | (11,605 | )              |      
|**Net loss per common share, basic and diluted |                                              |               | (0.56 | )              |   | (1.27         | )       |                | (0.75
|2005                                           |                                              |               |       |                |   |               |         |                |      
|                                               | Total revenues                               |               | $     | 385            |   | $             | 1339    |                | $    
|                                               | Product sales                                |               |       |               |   |               |        |                |      
|                                               | Cost of goods sold                           |               |       |               |   |               |        |                |      
|                                               | Research and development expenses            |               |       | 2,657          |   |               | 3,592   |                |      
|                                               | General and administrative expenses and fees |               |       | 752            |   |               | 487     |                |      
|                                               | Net loss                                     |               |       | (3,868         | ) |               | (3,394  | )              |      
|**Net loss per common share, basic and diluted |                                              |               | (0.43 | )              |   | (0.38         | )       |                | (0.52

---

96

---





Part III

Certain information required in Part III is omitted from this report, but is incorporated by reference from our definitive proxy statement for the 2008
Annual Meeting of Stockholders to be filed within 120 days after the end of our fiscal year ended December 31, 2007, pursuant to Regulation 14A with the Securities and Exchange
Commission.

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A.    Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.An evaluation of the effectiveness of the design
and operation of our "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as of the end of the period covered
by this Annual Report on Form 10-K was made under the supervision and with the participation of our management, including our Chief Executive Officer and Interim Chief Financial
Officer. Based upon this evaluation, our Chief Executive Officer and Interim Chief Financial Officer have concluded that our disclosure controls and procedures (a) are effective to ensure that
information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934 is timely recorded, processed, summarized and reported and (b) include,
without limitation, controls and procedures designed to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934 is accumulated
and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Management's Report on Internal Control over Financial Reporting.Management's report on internal
control over financial reporting is included in "Item 8. Financial Statements and Supplementary Data."

Changes in Internal Control over Financial Reporting.There have not been any changes in our internal
control over financial reporting that occurred during the year ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.

Item 9B.    Other Information.

None.

Item 10.    Directors, Executive Officers and Corporate Governance.

The information contained in our proxy statement under the captions "Information About the Board of Directors and Committees," "Corporate Governance," "Executive
Officers and Compensation" and "Section 16(a) Beneficial Ownership Reporting Compliance" is incorporated herein by reference.

We
have adopted the Osiris Therapeutics, Inc. Code of Business Conduct & Ethics for Members of the Board of Directors and Executive Officers and the Osiris
Therapeutics, Inc. Code of Conduct which applies to all our employees and members of the Board of Directors. These policies are publicly available on our website at
http://www//investor.osiris.com/documents.cfm.

Item 11.    Executive Compensation.

The information contained in our proxy statement under the caption "Executive Officers and Compensation" is incorporated herein by reference.

97

---



Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information contained in our proxy statement under the captions "Security Ownership of Certain Beneficial Owners and Management" and this Annual Report on
Form 10-K under the caption "Part IIItem 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
SecuritiesSecurities Authorized for Issuance under Equity Compensation Plans" is incorporated herein by reference.

Item 13.    Certain Relationships and Related Transactions, and Director Independence.

The information contained in our proxy statement under the caption "Executive Officers and CompensationCertain Relationships and Related Party
Transactions," "Information About the Board of Directors and Committees" and "Corporate Governance" is incorporated herein by reference.

Item 14.    Principal Accounting Fees and Services.

The information contained in our proxy statement under the caption "Auditor Services" is incorporated herein by reference.

98

---





Part IV

Item 15.    Exhibits, Financial Statement Schedules.



Schedules
not listed above have been omitted because the information required to be set forth therein is not applicable.

99

---







| |  | Exhibit Number |  | Description of Exhibit                                                                                                                       
| |  | -------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
| |  | 3.1           |  | Amended and Restated Certificate of Incorporation of the Registrant.                                                                         
| |  | 3.2           |  | Amended and Restated Bylaws of the Registrant.                                                                                               
| |  | 4.1           |  | Form of Common Stock Certificate.                                                                                                            
| |  | 10.1          |  | Amended and Restated 1994 Stock Incentive Plan, as amended.                                                                                  
| |  | 10.2          |  | 2006 Omnibus Plan.                                                                                                                           
| |  | 10.3          |  | Director Compensation Policy.                                                                                                                
| |  | 10.4          |  | Employment Agreement by and between the Registrant and C. Randal Mills, Ph.D., dated as of May 15, 2004.                                     
| |  | 10.5          |  | Employment Agreement by and between the Registrant and Cary J. Claiborne, dated as of December 3, 2004.                                      
| |  | 10.6          |  | Employment Agreement by and between the Registrant and Harry Carmitchel, dated as of September 1, 2004.                                      
| |  | 10.7          |  | Employment Agreement by and between the Registrant and Earl R. Fender, dated as of June 12, 2006.                                            
| |  | 10.8          |  | Loan Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 5, 2003, as amended.                       
| |  | 10.9          |  | Amendment No. 1 to the Loan Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 12, 2004.           
| |  | 10.10         |  | Security Agreement from the Registrant to Boston Scientific Corporation, dated as of March 12, 2004.                                         
| |  | 10.11*        |  | Contract Manufacturing Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 5, 2003.                 
| |  | 10.12*        |  | Development Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 5, 2003.                            
| |  | 10.13         |  | Investment Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 5, 2003.                             
| |  | 10.14         |  | Investor Rights Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 5, 2003.                        
| |  | 10.15*        |  | License Agreement by and between the Registrant and Boston Scientific Corporation, dated as of March 5, 2003.                                
| |  | 10.16         |  | Investor Rights Agreement by and between the Registrant and JCR Pharmaceuticals, Inc. dated August 26, 2003.                                 
| |  | 10.17*        |  | License Agreement by and between the Registrant and JCR Pharmaceuticals, Inc. dated August 26, 2003.                                         
| |  | 10.18*        |  | Distribution and Supply Agreement by and between the Registrant and Blackstone Medical, Inc., dated as of November 10, 2005.                 
| |  | 10.19         |  | Technology Transfer and License Agreement by and between the Registrant and Case Western University, dated as of January 1, 1993, as amended.
| |  | 10.20*        |  | Marketing Collaboration and License Agreement by and between the Registrant and BioWhittaker, Inc., dated as of August 11, 1999.             
| |  | 10.21         |  | Registration Rights Agreement by and between the Registrant and Cambrex Corporation, dated November 28, 2005.                                
| |  | 10.22        |  | Form of Convertible Promissory Note, dated October 30, 2006.                                                                                 
| |  | 10.23         |  | Lease Agreement by and between the Registrant and SAGA Limited Partnership, dated as of January 18, 1995, as amended.                        

100

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| |  | 10.24  |  | Second Amended and Restated Sublease Agreement by and between the Registrant and Maryland Economic Development Corporation, dated as of June 30, 1998, as amended.                                                                                                                                  
| |  | ------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 10.25  |  | Lease Agreement by and between Gateway S-8, LLLP and Nova Telecommunications, Inc., dated August 11, 1998, as amended.                                                                                                                                                                              
| |  | 10.27  |  | Agreement of Lease by and between the Registrant and Columbia Gateway S-28, L.L.C., dated June 6, 2006.                                                                                                                                                                                             
| |  | 10.28  |  | Consulting Agreement by and between the Registrant and Friedli Corporate Finance, Inc., f/k/a Friedli Corporate Finance AG, dated November 1995, as amended.                                                                                                                                        
| |  | 10.29  |  | Termination Letter from Friedli Corporate Finance, Inc., f/k/a Friedli Corporate Finance AG, to the Registrant, dated May 10, 2006.                                                                                                                                                                 
| |  | 10.30  |  | Indemnification Letter from Friedli Corporate Finance, Inc., f/k/a Friedli Corporate Finance AG, and Peter Friedli to the Registrant, dated May 19, 2006.                                                                                                                                           
| |  | 10.31  |  | Warrant to Purchase up to 1,000,000 shares of Common Stock granted by Registrant to Peter Friedli, dated May 24, 2006.                                                                                                                                                                              
| |  | 10.32 |  | Lock-up Agreement, dated October 30, 2006, by and among the Registrant, Peter Friedli, Friedli Corporate Finance, Inc. and US Venture 05, Inc.                                                                                                                                                      
| |  | 10.33 |  | Letter Agreement, dated October 30, 2006, by and between the Registrant and Friedli Corporate Finance, Inc.                                                                                                                                                                                         
| |  | 10.34  |  | Employment Agreement, dated July 31, 2006, by and between the Registrant and Lode Debrabandere.                                                                                                                                                                                                     
| |  | 10.35   |  | Letter Agreement, dated June 6, 2007, by and between Friedli Corporate Finance, Inc. and Osiris Therapeutics, Inc. (Incorporated herein by reference to Current Report on Form 8-K filed by the
Registrant with the SEC on June 7, 2007).                                                           
| |  | 10.36   |  | Form of Subscription Agreement, dated June 6, 2007, by and between the Registrant and Private Placement Investor (Incorporated herein by reference to Current Report on Form 8-K filed by the Registrant with the
SEC on June 7, 2007).                                                             
| |  | 10.37   |  | Amendment to Lock-up Agreement, acknowledged September 20, 2007, by and between the Registrant and Peter Friedli and Venturetec, Inc., (Incorporated herein by reference to Current Report on Form 8-K filed
by the Registrant with the SEC on September 20, 2007).                                 
| |  | 10.38   |  | Letter Agreement, dated October 3, 2007, between Friedli Corporate Finance, Inc. and the Registrant (together with forms of subscription agreements and promissory note), (Incorporated herein by reference to
Current Report on Form 8-K filed by the Registrant with the SEC on October 10, 2007).
| |  | 10.39   |  | Employment Separation Agreement and Release, dated November 23, 2007, by and between the Registrant and Cary J. Claiborne (Incorporated herein by reference to Current Report on Form 8-K filed by the Registrant
with the SEC on November 23, 2007).                                               
| |  | 10.40   |  | Form of Agreement, dated December 19, 2007, by and between the Registrant and the holders of Convertible Promissory Notes (Incorporated herein by reference to Registration Statement on Form S-3 filed by the
Registrant with the SEC on January 18, 2008).                                        

101

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| |  | 10.41  |  | Form of Subscription Agreement, dated December 19, 2007, by and between the Registrant and Private Placement Investor (Incorporated herein by reference to Current Report on Form 8-K filed by the Registrant with
the SEC on June 7, 2007).
| |  | ------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 10.42  |  | Termination Agreement, dated December 31, 2007, by and between the Registrant and Boston Scientific Corporation (filed herewith).                                                                                                           
| |  | 10.43  |  | Promissory Note, dated December 31, 2007, made by the Registrant in favor of Boston Scientific Corporation (filed herewith).                                                                                                                
| |  | 10.44  |  | Award/Contract, dated January 3, 2008, issued by the U.S. Army Space & Missile Defense Command to the Registrant (Incorporated herein by reference to Current Report on Form 8-K filed by the Registrant
with the SEC on January 4, 2008).  
| |  | 11.1.1 |  | Statement re: Computation of Per Share Loss (included in Note 1 to Financial Statements included in Part II Item 8 herein).                                                                                                                 
| |  | 23.1.1 |  | Consent of Independent Registered Public Accounting Firm (filed herewith).                                                                                                                                                                  
| |  | 31.1.1 |  | Rule 15d-14(a) Certification of C. Randal Mills, President and Chief Executive Officer (filed herewith).                                                                                                                                    
| |  | 31.2.1 |  | Rule 15d-14(a) Certification of Philip R. Jacoby, Jr., Interim Chief Financial Officer (filed herewith).                                                                                                                                    
| |  | 32.1.1 |  | Section 1350 Certification of C. Randal Mills, Chief Executive Officer, and Philip R. Jacoby, Jr., Interim Chief Financial Officer (filed herewith).                                                                                        

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102

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Signatures

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

|               |  | OSIRIS THERAPEUTICS, INC.
|-------------- |  | -------------------------
|March 17, 2008 |  | By:                      

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

|/s/C. RANDAL MILLSC. Randal Mills, Ph.D.      |  | President and Chief Executive Officer (principal executive officer)                                                  |  | March 17, 2008
|--------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | --------------
|/s/PHILIP R. JACOBY, JR.Philip R. Jacoby, Jr. |  | Interim Chief Financial Officer & Corporate Secretary (principal financial officer and principal accounting officer) |  | March 17, 2008
|/s/GREGORY H. BARNHILLGregory H. Barnhill     |  | Director                                                                                                             |  | March 17, 2008
|/s/PETER FRIEDLIPeter Friedli                 |  | Director                                                                                                             |  | March 17, 2008
|/s/FELIX GUTZWILLERFelix Gutzwiller           |  | Director                                                                                                             |  | March 17, 2008
|/s/JAY M. MOYESJay M. Moyes                   |  | Director                                                                                                             |  | March 17, 2008

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