**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **x**                                                                                                                                                                                                                                                                           | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                      | ** **                                                                                              |
| **For  the quarterly period ended March 31, 2008**                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                            |                                                                                                    |
| **o**                                                                                                                                                                                                                                                                           | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                      | ** **                                                                                              |
| **For  the transition period from                       to                     ** |

 

**CommissionFile Number—****001-32966**

 

**OSIRISTHERAPEUTICS, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                    | ** ** | **71-0881115**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**7015Albert Einstein Drive, Columbia, Maryland 21046**

(Address of principalexecutive offices) (Zip Code)

 

**443-545-1800**

(Registrant’s telephonenumber, including area code)

 

**None**

(Former name, formeraddress and former fiscal year, if changed since last report)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-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 x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

 

| **Class**                                 | ** ** | **Outstanding at May 9,  2008** |
|-------------------------------------------|------------|------------------------------------------------|
| Common Stock, par value  $0.001 per share |       | 31,765,941                                     |

 

** **

----

 

**OSIRISTHERAPEUTICS, INC.**

**INDEX**

 
| ** **                                    | ** **                                                                                      | ** ** |
|-----------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
| **PART I —  FINANCIAL INFORMATION** | 3                                                                                               |
| ** **                                    | ** **                                                                                      |       |
| Item 1.                                       | Financial  Statements — Unaudited.                                                         | 3          |
|                                          | Condensed Balance  Sheets — March 31, 2008 and December 31, 2007                 | 3          |
|                                          | Condensed  Statements of Operations — three months ended March 31, 2008 and 2007      | 4          |
|                                          | Condensed  Statement of Stockholders’ Equity — three months ended March 31, 2008 | 5          |
|                                          | Condensed  Statements of Cash Flows — three months ended March 31, 2008 and 2007      | 6          |
|                                          | Notes to  Condensed Financial Statements                                                        | 7          |
|                                          |                                                                                            |       |
| Item 2.                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.    | 10         |
|                                          |                                                                                            |       |
| Item 3.                                       | Quantitative  and Qualitative Disclosures About Market Risk.                                    | 15         |
|                                          |                                                                                            |       |
| Item 4.                                       | Controls and  Procedures.                                                                       | 15         |
|                                          |                                                                                            |       |
| **PART II — OTHER  INFORMATION**    | 16                                                                                              |
|                                          |                                                                                            |       |
| Item 1.                                       | Legal Proceedings.                                                                              | 16         |
| Item 1A.                                 | Risk Factors.                                                                                   | 17         |
| Item 2.                                       | Unregistered  Sales of Equity Securities and Use of Proceeds.                                   | 17         |
| Item 3.                                       | Defaults  Upon Senior Securities.                                                               | 17         |
| Item 4.                                       | Submission  of Matters to a Vote of Security Holders.                                           | 17         |
| Item 5.                                       | Other  Information.                                                                             | 17         |
| Item 6.                                       | Exhibits.                                                                                       | 17         |
|                                          |                                                                                            |       |
| Signature                                     |                                                                                            | 18         |
|                                          |                                                                                            |       |
| Exhibit Index                            |                                                                                            |       |

 

2

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**PART I — FINANCIAL INFORMATION**

 

**Item1.****                         Financial Statements - Unaudited**.

 

**OSIRISTHERAPEUTICS, INC.**

**CondensedBalance Sheets**

**Unaudited**

**Amounts in thousands**

 
| ** **                                                                                                       | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                       | ** ** |                     | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                       |       |                     |       |                        |       |
| Current assets:                                                                                                  |       |                     |       |                        |       |
| Cash                                                                                                             |       | $                        | 4,791      |                        | $          | 704 |   |
| Short-term investments                                                                                           |       | 7,280                    |       | 17,460                      |       |
| Accounts receivable                                                                                              |       | 360                      |       | 549                         |       |
| Prepaid expenses and  other current assets                                                                       |       | 1,334                    |       | 1,583                       |       |
| Current assets of  discontinued operations                                                                       |       | 8,649                    |       | 8,445                       |       |
| Total current assets                                                                                             |       | 22,342                   |       | 28,741                      |       |
|                                                                                                             |       |                     |       |                        |       |
| Property and equipment,  net                                                                                     |       | 1,629                    |       | 2,020                       |       |
| Restricted cash                                                                                                  |       | 280                      |       | 280                         |       |
| Other assets                                                                                                     |       | 1,106                    |       | 1,404                       |       |
| Long-term assets of  discontinued operations                                                                     |       | 5,539                    |       | 4,596                       |       |
| Total assets                                                                                                     |       | $                        | 30,896     |                        | $          | 37,041 |   |
|                                                                                                             |       |                     |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                   |       |                     |       |                        |       |
| Current liabilities:                                                                                             |       |                     |       |                        |       |
| Accounts payable and  accrued expenses                                                                           |       | $                        | 13,430     |                        | $          | 11,535 |   |
| Notes payable, current  portion                                                                                  |       | 12,891                   |       | 6,521                       |       |
| Capital lease  obligations, current portion                                                                      |       | 587                      |       | 886                         |       |
| Current liabilities of  discontinued operations                                                                  |       | 3,068                    |       | 2,552                       |       |
| Total current  liabilities                                                                                       |       | 29,984                   |       | 22,705                      |       |
|                                                                                                             |       |                     |       |                        |       |
| Note payable, net of  current portion                                                                            |       | —                   |       | 1,200                       |       |
| Capital lease  obligations, net of current portion                                                               |       | 8                        |       | 11                          |       |
| Total liabilities                                                                                                |       | 35,148                   |       | 37, 881                     |       |
|                                                                                                             |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                       |       |                     |       |                        |       |
| Common stock, $0.001  par value, 90,000 shares authorized 31,766 and 31,648 shares outstanding in  2008 and 2007 |       | 32                       |       | 32                          |       |
| Additional  paid-in-capital                                                                                      |       | 257,904                  |       | 255,728                     |       |
| Accumulated deficit                                                                                              |       | (257,024                 | )          | (241,424                    | )          |
| Total stockholders’  equity                                                                                 |       | 912                      |       | 14,336                      |       |
| Total liabilities and  stockholders’ equity                                                                 |       | $                        | 30,896     |                        | $          | 37,041 |   |

 

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

 

3

----

 

**OSIRISTHERAPEUTICS, INC.**

**CondensedStatements of Operations**

**Unaudited****Amounts in thousands, except per share data**

 
| ** **                                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                                                              |       |                                                 |       |   |   |
| Revenue from government contracts, collaborative  research licenses and royalties |       | $                                                    | 362        |   | $ | 279 |   |
|                                                                              |       |                                                 |       |   |   |
| Operating expenses:                                                               |       |                                                 |       |   |   |
| Research and  development                                                         |       | 16,694                                               |       | 8,494 |   |
| General and  administrative                                                       |       | 2,608                                                |       | 1,506 |   |
| Total operating  expenses                                                         |       | 19,302                                               |       | 10,000 |   |
|                                                                              |       |                                                 |       |   |   |
| Loss from operations                                                              |       | (18,940                                              | )          | (9,721 | ) |
|                                                                              |       |                                                 |       |   |   |
| Interest expense, net                                                             |       | (209                                                 | )          | (343 | ) |
|                                                                              |       |                                                 |       |   |   |
|         Loss from continuing operations        |       | (19,149                                              | )          | (10,064 | ) |
|                                                                              |       |                                                 |       |   |   |
| Income (loss) from  operations of discontinued operations                         |       | 3,549                                                |       | (1,437 | ) |
|                                                                              |       |                                                 |       |   |   |
| Net loss                                                                          |       | $                                                    | (15,600    | ) | $ | (11,501 | ) |
|                                                                              |       |                                                 |       |   |   |
| Basic and diluted net loss per share                                              |       |                                                 |       |   |   |
| (Loss) from continuing  operations                                                |       | $                                                    | (0.60      | ) | $ | (0.37 | ) |
| Income (loss) from  discontinued operations                                       |       | 0.11                                                 |       | (0.05 | ) |
| Net loss                                                                          |       | $                                                    | (0.49      | ) | $ | (0.42 | ) |
|                                                                              |       |                                                 |       |   |   |
| Weighted Average Common  Shares (basic and diluted)                               |       | 31,741                                               |       | 27,372 |   |

 

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

 

4

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**OSIRISTHERAPEUTICS, INC.**

**CondensedStatement of Stockholders’ Equity**

**For thethree months ended March 31, 2008UnauditedAmounts in thousands, except for share and per share data**

 
| ** **                                                                      | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated** | ** ** | **Total  Stockholders’** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|-------------------------------|------------|
| ** **                                                                      | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**                   | ** ** | **Equity** | ** ** |
| **Balance  at January 1, 2008**                                            |       | 31,648,437            |       | $                       | 32         |            | $          | 255,728                       |       | $ | (241,424 | ) | $ | 14,336 |   |
|                                                                            |       |                  |       |                    |       |            |       |                          |       |   |   |
| Induced conversion of  convertible notes into common stock ($14.00 per share)   |       | 89,380                |       | —                  |       | 1,498           |       | —                        |       | 1,498 |   |
|                                                                            |       |                  |       |                    |       |            |       |                          |       |   |   |
| Exercise of options to  purchase common stock ($0.40  per  share)          |       | 6,624                 |       | —                  |       | 3               |       | —                        |       | 3 |   |
|                                                                            |       |                  |       |                    |       |            |       |                          |       |   |   |
| Issuance of common  stock for services rendered by directors ($12.01 per share) |       | 21,500                |       | —                  |       | 258             |       | —                        |       | 258 |   |
|                                                                            |       |                  |       |                    |       |            |       |                          |       |   |   |
| Share-based payment —  employee compensation                               |       | —                |       | —                  |       | 417             |       | —                        |       | 417 |   |
|                                                                            |       |                  |       |                    |       |            |       |                          |       |   |   |
| Net loss                                                                        |       | —                |       | —                  |       | —          |       | (15,600                       | )          | (15,600 | ) |
|                                                                            |       |                  |       |                    |       |            |       |                          |       |   |   |
| **Balance  at March 31, 2008**                                             |       | 31,765,941            |       | $                       | 32         |            | $          | 257,904                       |       | $ | (257,024 | ) | $ | 912 |   |

 

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

 

5

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**OSIRISTHERAPEUTICS, INC.**

**CondensedStatements of Cash Flows**

**UnauditedAmounts in thousands**

 
| ** **                                                                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                                                                                                         |       |                                                 |       |   |   |
| **Cash  flows from operating activities:**                                                                                   |       |                                                 |       |   |   |
| **Continuing Operations:**                                                                                                   |       |                                                 |       |   |   |   |   |
|    Loss from continuing operations                                                                                 |       | $                                                    | (19,149    | ) | $ | (10,064 | ) |
|    **Adjustments  to reconcile loss****from continuing operations****to net cash used in continuing  operations:** |       |                                                 |       |   |   |
|   Depreciation and amortization                                                                                         |       | 481                                                  |       | 411 |   |
|   Non cash share-based payments                                                                                         |       | 650                                                  |       | 520 |   |
|   Non cash interest expense                                                                                             |       | 146                                                  |       | 60 |   |
| **  Changes in operating assets and  liabilities:**                                                                     |       |                                                 |       |   |   |
|   Accounts receivable                                                                                                   |       | 189                                                  |       | 82 |   |
|   Prepaid expenses and other current assets                                                                             |       | 250                                                  |       | 81 |   |
|   Other assets                                                                                                          |       | 279                                                  |       | 164 |   |
|   Accounts payable and accrued expenses                                                                                 |       | 1,895                                                |       | (864 | ) |
|   Deferred revenue                                                                                                      |       | —                                               |       | (238 | ) |
|   Long-term interest payable and other  liabilities                                                                     |       | —                                               |       | 100 |   |
|   Net cash used in continuing operations                                                                                |       | (15,259                                              | )          | (9,748 | ) |
| **Discontinued Operations:**                                                                                                 |       |                                                 |       |   |   |   |   |
|    Income (loss) from discontinued operations                                                                      |       |                                                 | 3,549      |   |   | (1,437 | ) |
| **  Adjustments to reconcile income (loss) to  net cash provided by discontinued operations:**                          |       |                                                 |       |   |   |
|   Depreciation and amortization                                                                                         |       | 42                                                   |       | 17 |   |
|   Non cash share-based payments                                                                                         |       | 25                                                   |       | 9 |   |
| **  Changes in operating assets and  liabilities:**                                                                     |       |                                                 |       |   |   |
|   Accounts receivable                                                                                                   |       | 369                                                  |       | 1.326 |   |
|   Inventory and other current assets                                                                                    |       | (574                                                 | )          | 1,154 |   |
|   Accounts payable and accrued expenses                                                                                 |       | 516                                                  |       | 118 |   |
| Net cash provided by  discontinued operations                                                                                |       | 3,927                                                |       | 1,187 |   |
|   Net cash used by operating activities                                                                                 |       | (11,332                                              | )          | (8,561 | ) |
|                                                                                                                         |       |                                                 |       |   |   |
| **Cash  flows from investing activities:**                                                                                   |       |                                                 |       |   |   |
| Purchases of property  and equipment                                                                                         |       | (1,077                                               | )          | (870 | ) |
| Proceeds from sale of  short-term investments                                                                                |       | 10,353                                               |       | 10,839 |   |
| Net cash provided by  investing activities                                                                                   |       | 9,276                                                |       | 9,969 |   |
|                                                                                                                         |       |                                                 |       |   |   |
| **Cash  flows from financing activities:**                                                                                   |       |                                                 |       |   |   |
| Principal payments on  capital lease obligations and notes payable                                                           |       | (1,932                                               | )          | (290 | ) |
| Restricted cash                                                                                                              |       | —                                               |       | 6 |   |
| Proceeds from  convertible notes payable                                                                                     |       | 8,000                                                |       | — |   |
| Proceeds from the  exercise of stock options                                                                                 |       | 3                                                    |       | 54 |   |
| Net cash provided by  (used in) financing activities                                                                         |       | 6,071                                                |       | (230 | ) |
|                                                                                                                         |       |                                                 |       |   |   |
| Net increase in cash                                                                                                         |       | 5,015                                                |       | 1,178 |   |
| Cash at beginning of  period                                                                                                 |       | 704                                                  |       | 714 |   |
|                                                                                                                         |       |                                                 |       |   |   |
| **Cash  at end of period:**                                                                                                  |       | $                                                    | 4,719      |   | $ | 1,892 |   |
|                                                                                                                              |            |                                                      |            |  |  |  |  |  |  |

 

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

 

6

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**OSIRISTHERAPEUTICS, INC.**

**NOTESTO CONDENSED FINANCIAL STATEMENTS**

**Amountsin thousands, except for share and per share data**

 

**1.             Basis of Presentation**

 

The accompanying unaudited condensed financialstatements of Osiris Therapeutics, Inc. (the “Company”) have been preparedin accordance with generally accepted accounting principles in the UnitedStates and the rules and regulations of the Securities and ExchangeCommission (the “SEC”), for interim financial information.  Accordingly,they do not include all the information and footnotes required by generallyaccepted accounting principles for complete financial statements and should beread in conjunction with the Company’s Annual Report on Form 10-K for theyear ended December 31, 2007.  The interim financial statements areunaudited, but in the opinion of management all adjustments, consisting only ofnormal recurring accruals, considered necessary for a fair statement of theresults of these interim periods have been included.  The results of theCompany’s operations for any interim period are not necessarily indicative ofthe results that may be expected for any other interim period or for a fullfiscal year.

 

**2.             Significant Accounting Policies and Recent Accounting Pronouncements**

 

***Use of Estimates***

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes.  Due to the inherent uncertainty involved inmaking those assumptions, actual results could differ from thoseestimates.  We believe that the mostsignificant estimates that affect our financial statements are those thatrelate to inventory valuation, deferred tax assets, and share-basedcompensation.

 

***Revenue Recognition***

 

Our revenue recognition policies are in accordancewith the SEC’s Staff Accounting Bulletin No. 101, *Revenue Recognition in Financial Statements*,as amended by SEC Staff Accounting Bulletin No. 104, *Revenue Recognition*.

 

In January 2008, we were awarded a contract fromthe United States Department of Defense (“DoD”) to develop and stockpileProchymal for the repair of gastrointestinal injury resulting from radiationexposure, and began recognizing contract revenue during the first quarter of2008.  Contract revenue is recognized asthe related costs are incurred, in accordance with the terms of the governmentcontract.

 

***Loss per CommonShare***

 

Basic loss per common share is calculated by dividingnet loss by the weighted average number of common shares outstanding during theperiod. Diluted loss per common share adjusts basic loss per share for thepotentially dilutive effects of common share equivalents, using the treasurystock method. All common equivalent shares from the conversion of convertibledebt and outstanding stock options and warrants are excluded from thecomputation of diluted loss per share as their effect is antidilutive.

 

***Stock-Based CompensationPlans***

 

In 1994, we adopted the Amended and Restated 1994Stock Incentive Plan (the “1994 Plan”) under which 875,000 shares of commonstock have been reserved for issuance upon the exercise of options or otherequity grants that we issue from time to time.  In 2006, we adopted the2006 Omnibus Plan, under which we reserved 850,000 shares of common stockfor issuance upon the exercise of stock options or other equity grants. We stopped granting options under the 1994 Plan upon the completion of our initialpublic offering in August 2006.

 

A summary of the combined activity under both of ourstock-based compensation plans as of March 31, 2008 and changes during thethree months then ended is presented below.

 

7

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| ** **                             | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price Per Share  at Grant Date** | ** ** | **Weighted Average  Remaining Term  (in Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding at  December 31, 2007 |       | 880,410                    |       | $                                                                                           | 8.64       |                                                            | 7.2        |                                | $          | 5,091 |   |
| Granted                                |       | 277,500                    |       | 11.95                                                                                       |       |                                                            |       |                                |       |
| Exercised                              |       | (6,624                     | )          | 0.40                                                                                        |       |                                                            |       | 73                                  |       |
| Forfeited or expired                   |       | (2,000                     | )          | 9.40                                                                                        |       |                                                            |       |                                |       |
| Outstanding at  March 31, 2008    |       | 1,149,286                  |       | 9.40                                                                                        |       | 8.5                                                             |       | 5,497                               |       |
|                                   |       |                       |       |                                                                                        |       |                                                            |       |                                |       |
| Exercisable at  March 31, 2008    |       | 399,024                    |       | 3.73                                                                                        |       | 7.2                                                             |       | 3,996                               |       |
|                                        |            |                            |            |                                                                                             |            |                                                                 |            |                                     |            |  |  |

 

The weighted average grant date fair value of optionsgranted during the three months ended March 31, 2008 was $7.94 pershare. We received a total of $3 in cash from the exercise of options duringthe three months ended March 31, 2008.

 

Also during the three months ended March 31,2008, we granted 21,500 unrestricted shares of common stock to members of ourBoard of Directors under our 2006 Omnibus Plan and recognized $258 inshare-based expense.  As of March 31, 2008, 129,260 shares of commonstock remain available for future grants under our 2006 Omnibus Plan.

 

Share-based compensation, (including directorcompensation) included in the statements of operations for the three monthsended March 31, 2008 and 2007 was:

 
| ** **                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Biologic drug  candidates   |       | $                                                |  229  |   | $ |  144 |   |
| Discontinued operations     |       | 25                                               |       | 9 |   |
| General and  administrative |       | 421                                              |       | 376 |   |
| Total                       |       | $                                                |  675  |   | $ |  529 |   |

 

As of March 31, 2008, there was approximately$5.8 million of total unrecognized share-based compensation cost related tooptions granted under our plans that will be recognized over a weighted-averageperiod of approximately 3.5 years.

 

***Supplemental CashFlow Information***

 
| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **Supplemental  disclosure of cash flows information:**                    |       |                                             |       |   |   |
| Cash paid for interest                                                     |       | $                                                | 208        |   | $ | 101 |   |
| Cash paid for taxes                                                        |       | —                                           |       | — |   |
|                                                                       |       |                                             |       |   |   |
| **Supplemental  schedule of non-cash investing and financing activities:** |       | ** **                                       | ** ** | ** ** | ** ** |
| Common stock issued to  directors for services rendered                    |       | 258                                              |       | 295 |   |
|                                                                            |            |                                                  |            |  |  |  |  |

 

***Significant NewAccounting Pronouncements***

 

In March 2008, theFASB issued SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities—an amendment of FASB StatementNo. 133.*” SFAS No. 161 will require entities to providequalitative disclosures about the objectives and strategies for usingderivatives, quantitative disclosures about the fair value of gains and losseson derivative contracts, and disclosures about credit-risk related tocontingent features in their hedged positions. The statement also asks entitiesto disclose more information about (i) the location and amounts ofderivative instruments in financial statements; (ii) how derivatives andrelated hedges are accounted for under SFAS No. 133; and (iii) howthe hedges affect the entity’s financial position, financial performance andcash flows. The statement is effective for fiscal years and interim periodsbeginning after November 15, 2008, with early application encouraged, butnot required. As of March 31, 2008 we have not adopted SFAS No. 161.We do not expect the adoption of SFAS No. 161 to have a material impact onour financial statements.

 

8

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**3.             Discontinued Operations**

 

In April 2008, we committed to a plan to sell ourbiologic tissue product practice, including our entire product line relating tothe processing, manufacturing, marketing and selling of Osteocel® and Osteocel®XO, an allograft material containing cancellous bone, used in spinal fusion andother surgical procedures.  We refer tothese assets as our Osteocel asset disposal group.  Not included among the Osteocel assetdisposal group is Osteocel® XC, our second generation product candidate underdevelopment for bone repair, utilizing culture expanded mesenchymal stem cellsto create a synthetic version of Osteocel. On May 8, 2008, we entered into a definitive agreement to sell theOsteocel asset disposal group to NuVasive, Inc., a Delawarecorporation.  Our ability to consummatethe sale is subject to, among other things, the expiration of the applicablewaiting period (including any extensions) under the U.S. Hart-Scott-RodinoAct.  We are also seeking stockholderapproval, to satisfy any approvals which may be required in respect of the saleunder Delaware law.  We expect to closethe transaction during the second or third quarter of 2008, recognizing a gain.

 

The net assets of the Osteocel asset disposal groupwere as follows, at March 31, 2008 and December 31, 2007:

 
| ** **                                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Accounts receivable                            |       | $        | 3,955      |     | $          | 4,324 |   |
| Inventory                                      |       | 4,622    |       | 3,983    |       |
| Other current assets                           |       | 72       |       | 138      |       |
|                                           |       |     |       |     |       |
| Current assets of discontinued operations      |       | 8,649    |       | 8,445    |       |
|                                           |       |     |       |     |       |
| Property and equipment, net                    |       | 5,539    |       | 4,596    |       |
|                                           |       |     |       |     |       |
| Current liabilities of discontinued operations |       | 3,068    |       | 2,552    |       |
|                                           |       |     |       |     |       |
| Net assets of discontinued operations          |       | $        | 11,120     |     | $          | 10,489 |   |

 

We eliminated the operations of the businesscomponents of the Osteocel asset disposal group from our ongoing operations asa result of the disposal transaction and have presented the results of thegroup’s operations as a discontinued operation for all periods. Summarizedoperating results of the Osteocel asset disposal group are as follows:

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **March 31,**               | ** ** |
| ** **                                               | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Product Sales                                            |       | $                                | 7,511      |   | $ | 2,000 |   |
| Cost of goods sold                                       |       | 3,781                            |       | 901 |   |
| Gross Profit                                             |       | 3,730                            |       | 1,099 |   |
|                                                     |       |                             |       |   |   |
| Failed production runs                                   |       | —                           |       | 2,433 |   |
| General & administrative expenses               |       | 181                              |       | 103 |   |
|                                                     |       | 181                              |       | 2,536 |   |
|                                                     |       |                             |       |   |   |
| Income (loss) from operations of discontinued operations |       | $                                | 3,549      |   | $ | (1,437 | ) |

 

**4.             Notes Payable**

 

In March 2008, we issued $8.0 million inconvertible promissory notes in a private placement to several non-U.S.investors pursuant to a private placement intended to qualify under RegulationS and Section 4(2) of the Securities Act of 1933, as amended.  The notes bear interest at a rate of 2% perannum and become due and payable on November 30, 2008.  The notes are convertible at the option ofthe respective holders at any time, into shares of common stock at conversionprices ranging from $12.04 to $12.17 per share (the respective closing priceson the NASDAQ Global Exchange on the dates of the definitive agreements). Thenotes provide for redemption at any time at our option, with 30-days priorwritten notice.  The note holders areafforded certain registration rights in respect of any shares issued uponconversion.

 

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

 

**Forward-Looking Information**

 

This report includes“forward-looking statements” within the meaning of Section 21E of theSecurities Exchange Act of 1934, or the Exchange Act. Forward-lookingstatements include statements concerning our plans, objectives, goals,strategies, future events, future revenues or performance, capitalexpenditures, compensation arrangements, financing needs, plans or intentionsrelating to acquisitions, business trends and other information that is nothistorical information and, in particular, may appear under the headings “RiskFactors” in our Annual Report 10-K under Part I—Item 1A, “Part II—Item7. Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and the other documents we file with the Securities and ExchangeCommission, or SEC, including, among others, our quarterly reports on Form 10-Qand any amendments thereto. When used in this Quarterly Report, the words *estimates, expects, anticipates, projects, plans,intends, believes, forecasts* and variations of such words or similarexpressions are intended to identify forward-looking statements. Examples offorward-looking statements include, but are not limited to, statementsregarding the following: our product development efforts; our clinical trialsand anticipated regulatory requirements; the success of our product candidatesin development; status of the regulatory process for our biologic drug candidates;implementation of our corporate strategy; our financial performance; ourproduct research and development activities and projected expenditures,including our anticipated timeline and clinical strategy for mesenchymal stemcells and biologic drug candidates; our cash needs; patents and proprietaryrights; ability of our potential products to treat disease; our plans for salesand marketing; our plans regarding facilities; types of regulatory frameworkswe expect will be applicable to our potential products; and results of ourscientific research. All forward-looking statements, including, withoutlimitation, management’s examination of historical operating trends, are basedupon our current expectations and various assumptions. Our expectations, beliefsand projections are expressed in good faith and we believe there is areasonable basis for them. However, there can be no assurance that management’sexpectations, beliefs and projections will result or be achieved.

 

You should read thefollowing management’s discussion and analysis of our financial condition andresults of operations in conjunction with our audited Financial Statements andrelated notes thereto and other disclosures included as part of our AnnualReport on Form 10-K for the year ended December 31, 2007, and ourunaudited Condensed Financial Statements for the three months ended March 31,2008 and other disclosures included in this Quarterly Report on Form 10-Q.Our Condensed Financial Statements have been prepared in accordance with U.S.generally accepted accounting principles and are presented in U.S. dollars.

 

There are a number of risksand uncertainties that could cause our actual results to differ materially fromthe forward-looking statements contained in this report. Some of the importantfactors that could cause our actual results to differ materially from theforward-looking statements we make in this report are set forth in this report,including under the heading “Risk Factors”, or in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2007 under Part I — Item 1A“Risk Factors.” There may be other factors that may cause our actual results todiffer materially from the forward-looking statements.

 

All forward-lookingstatements attributable to us or persons acting on our behalf apply only as ofthe date of this Quarterly Report and are expressly qualified in their entiretyby the cautionary statements included herein. We undertake no obligation topublicly update or revise any forward-looking statements to reflect subsequentevents or circumstances and do not intend to do so.

 

When we use the terms“Osiris,” “we,”  “us,” and “our” we mean Osiris Therapeutics, Inc., aDelaware corporation.

 

**Introduction and Overview**

 

The following is adiscussion and analysis of our financial condition and results of operationsfor the three month periods ended March 31, 2008 and 2007.  Youshould read this discussion together with the accompanying unaudited condensedfinancial statements and notes and with our Annual Report on Form 10-K forthe year ended December 31, 2007.  Historical results and anydiscussion of prospective results may not indicate our futureperformance.  See “Forward Looking Information.”

 

        Weare a leading stem cell therapeutic company headquartered in Columbia, Marylandand focused on developing and marketing products to treat medical conditions inthe inflammatory, orthopedic, and cardiovascular areas. We were incorporated inDelaware in April 2002. Our predecessor company was organized in 1992. Ourlead biologic drug candidate, ProchymalTM, is being evaluated in Phase IIIclinical trials for three indications, including acute and steroid refractoryGraft versus Host Disease (“GvHD”) and Crohn’s disease, and is the only stemcell therapeutic currently granted both Orphan Drug and Fast Track status bythe Food and Drug Administration (“FDA”). Prochymal is also being developed forthe repair of heart tissue following a heart attack and for protection ofpancreatic islet cells in patients with type 1 diabetes. Our pipeline ofinternally developed biologic drug candidates under evaluation also includesChondrogen for osteoarthritis in the knee. We have also partnered with GenzymeCorporation to develop Prochymal as a medical countermeasure to nuclear terrorismand other radiological emergencies.

 

        Osirisis 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 ourtechnology in the United States and a number 

 

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of foreign countriesincluding 47 U.S. and 253 foreign patents owned or licensed. We believe thatour biologic drug candidates have advantages over other stem cell therapeuticsin development for the following reasons:

 

·                  **Stem Cell Source.**   Our stem cells are obtained from adult bone marrow, areadily available source. The cells are drawn from the hips of volunteer donorsbetween the ages of 18 and 30 years, using a simple needle and syringeaspiration. Because the cells are obtained from consenting adult donors, we areable to largely avoid the ethical controversy surrounding embryonic and fetalstem cell research.

 

·                  **Ability to Mass Produce.**   Through our proprietarymanufacturing methods, we can grow MSCs in a controlled fashion to produce upto 10,000 treatments of our biologic drug candidates from a single bone marrowdonation. Our ability to produce a large quantity of treatments from onedonation provides us with manufacturing efficiencies and product consistencythat are essential to commercialization.

 

·                  **Universal Compatibility.**   Many stem cell therapies underdevelopment can elicit a rejection response in the recipient and thereforerequire donor-to-recipient matching or potentially harmful immunosuppression.This greatly reduces manufacturing efficiencies and creates a risk of mismatchwhich can result in an acute inflammatory response and, potentially, in death.Based on our clinical experience, we believe that our biologic drug candidatesare not rejected by the patient’s immune system and so, like type Onegative blood, do not require matching. This universal compatibility allows usto produce a standardized product available to all patients in almost anymedical setting.

 

·                  **Treatment on Demand.**   Our biologic drug candidates can be stored frozen atend-user medical facilities until they are needed. We anticipate that medicalfacilities will be able to prescribe and dispense these products in much thesame way as conventional drugs. In contrast, other stem cell technologies underdevelopment require weeks to prepare after a patient’s need is identified. Thisis a key feature of our technology, as many patients in the critical caresetting require prompt treatment.

 

        Thefollowing table summarizes key information about our biologic drug candidates.

 
| **Product/Candidate** | ** ** | **Indication**                                  | ** ** | **Status**      |
|-----------------------|------------|-------------------------------------------------|------------|-----------------|
| **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 |

 

We have incurred annualoperating losses since inception and expect to incur substantial operatinglosses in the future in connection with the development of our core products.As of March 31, 2008, we had an accumulated deficit of $257 million.

 

In addition to our biologicdrug candidates, we produce and since July 2005 have marketed Osteocel forregenerating bone in orthopedic indications.  Osteocel is our onlycommercial product and generated revenue of approximately $7.5 million for thethree months ended March 31, 2008. We manufacture Osteocel in our Baltimore, Maryland clean-room facilitiesfor distribution by us and others for use in orthopedic indications and spinalprocedures.  In April 2008, however,we committed to a plan to sell our Osteocel related assets, and on May 8,2008 entered into an asset purchase agreement to sell those assets, includingour entire product line relating to the processing, manufacturing, marketingand selling of Osteocel and Osteocel XO to NuVasive, Inc.  Our ability to consummate the sale is subjectto a number of risks and uncertainties, and conditions precedent, including theexpiration of the applicable waiting period (including any extensions) underthe U.S. Hart-Scott-Rodino Act.  We arealso seeking stockholder approval for the sale and expect to close the transactionduring the second or third quarter of 2008, recognizing a gain.

 

**Financial Operations Overview**

 

*Revenue*

 

We recognize revenue oncollaborative and royalty agreements and a contract with the United StatesDepartment of Defense for the development and stockpiling of Prochymal for thetreatment of acute radiation syndrome.

 

*Research and Development Costs*

 

Our research and developmentcosts consist of expenses incurred in identifying, developing and testingbiologic drug candidates. These expenses consist primarily of salaries andrelated expenses for personnel, fees paid to professional service providers forindependent 

 

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monitoring and analysis of ourclinical trials, costs of contract research and manufacturing, costs offacilities, and the costs of manufacturing clinical batches of biologic drugcandidates, quality control supplies and material to expand biologic drugcandidates.

 

Consistent with our focus onthe development of biologic drug candidates with potential uses in multipleindications, many of our costs are not attributable to a specificallyidentified project. We use our employee and infrastructure resources acrossseveral projects. Accordingly, we do not account for internal research anddevelopment costs on a project-by-project basis. As a result, we cannot stateprecisely the total costs incurred for each of our clinical and preclinicalprojects on a project-by-project basis. From inception in December 1992through March 31, 2008, we incurred aggregate research and developmentcosts of approximately $251 million. We expect our research and developmentexpenses to increase substantially in the future, as we expand our clinicaltrial activity, as our biologic drug candidates advance through the developmentcycle and as we invest in additional product opportunities and researchprograms. Clinical trials and preclinical studies are time-consuming andexpensive. Our expenditures on current and future preclinical and clinicaldevelopment programs are subject to many uncertainties. We test our products inseveral preclinical studies, and we then conduct clinical trials for thosebiologic drug candidates that we determine to be the most promising. As weobtain results from clinical trials, we may elect to discontinue or delaytrials for some biologic drug candidates in order to focus our resources onmore promising biologic drug candidates. Completion of clinical trials may takeseveral years or more, but the length of time generally varies substantiallyaccording to the type, size of trial and intended use of a biologic drugcandidate. The cost of clinical trials may vary significantly over the life ofa project as a result of a variety of factors, including:

 

·               the number of patients who participate inthe trials;

 

·               the number of sites included in the trials;

 

·               the length of time required to enroll trialparticipants;

 

·               the duration of patient treatment andfollow-up;

 

·               the costs of producing supplies of thebiologic drug candidates needed for clinical trials and regulatory submissions;

 

·               the efficacy and safety profile of thebiologic drug candidate; and

 

·               the costs and timing of, and the ability tosecure, regulatory approvals.

 

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

 

*General and Administrative Expenses*

 

General and administrativeexpenses consist primarily of the costs associated with our general management,including salaries, allocations of facilities and related costs, andprofessional fees such as legal and accounting expenses. In anticipation of thecommercialization and bringing our biologic drug candidates to market, we areincurring increases in our general and administrative expense in the areas ofbusiness development and intellectual property. We have also incurred increased general and administrative costs forlegal and accounting compliance costs, investor relations and other activitiesassociated with operating as a publicly traded company. Continued increaseswill also likely result from the additional hiring of operational, financial,accounting, facilities engineering and information systems personnel.

 

*InterestExpense, Net*

 

Interest income consists ofinterest earned on our cash and short-term investments. Interest expenseconsists of interest incurred on convertible debt, capital leases and otherdebt financings. We pay interest on our bank loan, capital leases and ourconvertible long-term debt.

 

*Income Taxes*

 

We have not recognized anydeferred tax assets or liabilities in our financial statements since we cannotassure their future realization. Because realization of deferred tax assets isdependent upon future earnings, a full valuation allowance has been recorded onthe net deferred tax assets, which relate primarily to net operating loss andresearch and development carry-forwards. In the event that we become profitablewithin the next several years, we have net deferred tax assets of approximately$75 million that may be utilized prior to us having to recognize any income taxexpense or make payments to the taxing authorities. Utilization of our netoperating loss carry-forwards in any one year may be limited under InternalRevenue Code Section 382, and we could be subject to the alternativeminimum tax.

 

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**Critical Accounting Policies**

 

There have been no materialchanges in our critical accounting policies, estimates and judgments during thethree months ended March 31, 2008 compared to the disclosures in Part II,Item 7 of our Annual Report on Form 10-K for the year ended December 31,2007, other than as disclosed herein.

 

**Results of Operations**

 

***Comparison of Quarters ended March 31,2008 and 2007***

 

*Revenues (excluding discontinued operations)*

 

Revenues for the threemonths ended March 31, 2008 totaled $0.4 million, consisting of $0.3million in contract revenue from the Department of Defense contract and $0.1million in royalties. Revenues for the three months ended March 31, 2007were $0.3 million, which consisted primarily of the recognition of license feesfrom research, development and commercialization collaborative agreements withan international pharmaceutical company. These collaborative agreements wereterminated in December 2007 and upon such termination we regained theworldwide rights to Prochymal for cardiac indications.

 

*Research and Development Expenses*

 

Research and developmentexpenses were approximately $16.7 million for the three months ended March 31,2008 compared to $8.5 million for the comparable period in 2007,reflecting the increase in our clinical trial activities. At March 31,2008, we are conducting three Phase III clinical trials in several inflammatorydisease indications, Phase II clinical trials for acute myocardial infarctionand type I diabetes and conducting preclinical research on acute radiationsyndrome.

 

*General and Administrative Expenses (excluding discontinuedoperations)*

 

General and administrativeexpenses were $2.6 million for the three months ended March 31, 2008compared to $1.5 million in the corresponding period in fiscal 2007.  The increased costs in 2008 includefacilities costs associated with leasing and operating plants in Columbia andBaltimore, Maryland (the Baltimore facility is scheduled to close in the thirdquarter of 2008), increased legal costs associated with our intellectualproperty and increases in our managerial level staff in anticipation ofqualifying and commercializing our biologic drug candidates.

 

*Interest Expense, Net*

 

Interest expense, net was$0.2 million for the three months ended March 31, 2008 compared to$0.3 million in the corresponding period in fiscal 2007.

 

*Income (Loss) from Operations of Discontinued Operations*

 

Income from operations ofthe Osteocel asset disposal group were $3.5 million for the three months ended March 31,2008 compared to a loss of $1.4 million for the comparable period in 2007, asfollows:

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **March 31,**               | ** ** |
| ** **                                                | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                                      |       | **(Amounts  in thousands)**      |       |
| Product Sales                                             |       | $                                | 7,511      |   | $ | 2,000 |   |
| Cost of goods sold                                        |       | 3,781                            |       | 901 |   |
| Gross Profit                                              |       | 3,730                            |       | 1,099 |   |
|                                                      |       |                             |       |   |   |
| Failed production runs                                    |       | —                           |       | 2,433 |   |
| General & administrative expenses                |       | 181                              |       | 103 |   |
|                                                      |       | 181                              |       | 2,536 |   |
|                                                      |       |                             |       |   |   |
| Income (loss) from operations of discontinued  operations |       | $                                | 3,549      |   | $ | (1,437 | ) |

 

In April 2008, wecommitted to a plan to sell our biologic tissue product practice, consisting ofthe Osteocel asset disposal group. On May 8, 2008, we entered into adefinitive agreement to sell the Osteocel asset disposal group.  We expect to close the transaction during thesecond or third quarter of 2008, recognizing a gain.

 

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**Liquidity and Capital Resources**

 

***Liquidity***

 

At March 31, 2008, wehad $12.0 million in cash and short-term investments. In addition, in October 2007,we obtained a $30.0 million financing commitment from Friedli Corporate Finance, Inc.,which is owned by Peter Friedli who is the Chairman of our Board of Directorsand largest shareholder. This financing commitment is for a twelve month termand provides for financing through the issuance by us of common stock issued ata price determined as the basis of market value, or 3-year promissory notesbearing interest at LIBOR plus 4%. Although we control the timing of draws madeduring the term of the commitment, if any, Friedli Corporate Finance, Inc.determines whether we issue common stock or promissory notes, subject, howeverto certain limitations as to the aggregate number of shares of common stockthat may be issued. We did not incur any fees in connection with this financingcommitment and have made no draws under such commitment.

 

At March 31, 2008, ourshort-term debt consisted of $4.9 million due in quarterly installments throughJanuary 2009 and payable to an international pharmaceutical company and$8.0 million in convertible notes payable to several noteholders, including Mr. Friedli,which mature on November 30, 2008. The convertible notes may be convertedinto common stock at any time at the discretion of the note holders.  The notes also provide for redemption at anytime at our option, with 30-days prior written notice.

 

***Cash Flows***

 

Net cash usedin operating activities was $11.3 million for the three months ended March 31,2008, which is comprised of net cash used in continuing operations of $15.3million, netted against net cash provided by discontinued operations of $3.9million.  Net cash used in operatingactivities during the three months ended March 31, 2007 was $8.6 million, whichis comprised of net cash used in continuing operations of $9.8 million, nettedagainst net cash provided by discontinued operations of $1.2 million.

 

Net cash usedin continuing operations during the first quarter of 2008 reflects the lossfrom continuing operations of $19.1 million, partially offset by $2.6 millionin favorable changes in our working capital and $1.2 million of non-cashcharges.  Net cash used in continuingoperations during the three months ended March 31, 2007 was $9.7 million,reflecting our loss from continuing operations of $10.1 million, netted againstunfavorable changes in working capital of $0.6 million and non-cash charges of$1.0 million.

 

Net cashprovided by discontinued operations during the first quarter of 2008 reflectsthe income from discontinued operations of $3.5 million, increased by favorablechanges in working capital of discontinued operations of $0.3 million andnon-cash charges of $0.1 million.  Net cashprovided by discontinued operations during the three months ended March 31,2007 was $1.2 million and reflects our loss from discontinued operations of$1.4 million offset by favorable changes in working capital of discontinuedoperations of $2.6 million.  Thefavorable changes in working capital of discontinued operations in the firstquarter of 2007 are primarily reductions in accounts receivable and inventoryrelated to the failed production runs associated with the expansion of ourBaltimore, MD manufacturing facility.

 

Net cash provided byinvesting activities was $9.3 million for the three months ended March 31,2008, including $1.1 million of capital expenditures spent primarily onour manufacturing facilities in Columbia, Maryland, partially offset bythe sale of $10.4 million of short-term investments. Net cash used ininvesting activity for the three months ended March 31, 2007 was $10.0million.

 

Net cash provided byfinancing activities was $6.1 million for the three months ended March 31,2008. This includes scheduled payments on our capital leases and notes, offsetby the $8.0 million proceeds from the issuance of convertible promissory notesin March 2008. Cash used in financing activities during the three monthsended March 31, 2007 was $0.2 million.

 

***Capital Resources***

 

Our future capitalrequirements will depend on many factors, including, but not limited to:

 

·                       the closing of the transaction providing forthe sale of the Osteocel asset disposal group and performance under the relatedmanufacturing agreement;

 

·                       the scope and results of our research andpreclinical development programs;

 

·                       the scope and results of our clinical trials,particularly regarding the number of patients required for our Phase III trialsfor   Prochymal;

 

·                       the timing of and the costs involved inobtaining regulatory approvals for our biologic drug candidates, which could bemore lengthy or complex than obtaining approval for a new conventional drug,given the FDA’s limited experience with late-stage clinical trials andmarketing approval for stem cell therapeutics;

 

·                       the costs of maintaining, expanding andprotecting our intellectual property portfolio, including litigation costs andliabilities;

 

·                       the costs of repaying our debt; and

 

·                       the costs of enlarging our work forceconsistent with expanding our business and operations and status as a publiccompany, and as necessary to enhance and train our sales network inanticipation of the approval of our biologic drug candidates for commercialsale.

 

As a result of these andother factors, we will likely need or choose to seek additional funding priorto our becoming cash flow positive on an operational basis. We would likelyseek such funding through public or private financings or some combination ofthem. Although not our current focus, we might also seek funding throughcollaborative arrangements if determined to be necessary or appropriate. 

 

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We are also pursuing governmentcontracts in an effort to help offset the remaining development costs andreduce adoption risks by securing advanced purchase commitments for Prochymal.Additional funding may not be available to us on acceptable terms, or at all.If we obtain capital through collaborative arrangements, these arrangementscould require us to relinquish rights to our technologies or biologic drugcandidates. If we raise capital through the sale of equity, or securitiesconvertible into equity, dilution to our then existing stockholders wouldresult. If we raise additional capital through the incurrence of debt, we wouldlikely become subject to covenants restricting our business activities, andholders of debt instruments would have rights and privileges senior tothose of our equity investors. In addition, servicing the interest andrepayment obligations under these borrowings would divert funds that wouldotherwise be available to support research and development, clinical orcommercialization activities.

 

We expect that our availablecash and interest income, including the availability under our line-of-creditand financing commitment, will be sufficient to finance currently planned activitiesthrough at least 2008. These estimates are based on certain assumptions, whichcould be negatively impacted by the matters discussed under “Risk Factors” inthis report and our Annual Report on Form 10-K, among other things.

 

If adequate funds are notavailable, we may be required to delay, reduce the scope of, or eliminate oneor more of our research and development programs, which may have a materialadverse affect on our business, financial condition and results of operations.See “Risk Factors” in this report and our Annual Report on Form 10-K.

 

**Off-Balance Sheet Arrangements.**

 

We have no off-balance sheetfinancing arrangements and we have not entered into any transactions involvingunconsolidated subsidiaries or special purpose entities.

 

**Item3.              Quantitative and Qualitative Disclosures About Market Risk**.

 

Due to the short duration ofour investment portfolio and the high quality of our investments, an immediate10% change in interest rates would not have a material effect on the fairmarket value of our portfolio. However, our investment portfolio consists ofinvestment grade auction rate certificates which are presently illiquid at parvalue.  In the event we sold one of theseauction rate securities presently in the secondary market, we may experience aloss of between 5% - 15% of the par value. Our portfolio managers are presently unable to provide us with anestimate of how long the credit crisis in the auction rate certificate marketwill exist.

 

We believe that the interestrate risk related to our accounts receivable is not significant. We manage therisk associated with these accounts through periodic reviews of the carryingvalue for non-collectability and establishment of appropriate allowances inconnection with our internal controls and policies.

 

We do not enter into hedgingor derivative instrument arrangements.

 

**Item4.              Controls and Procedures.**

 

***Evaluation of Disclosure Controls and Procedures.*** An evaluation of the effectiveness of thedesign and operation of our “disclosure controls and procedures” (as defined inRule 13a-15(e) under the Securities Exchange Act of 1934, asamended), as of the end of the period covered by this Quarterly Report on Form 10-Qwas made under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer. Based uponthis evaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures (a) are effective toensure that information required to be disclosed by us in reports filed orsubmitted 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 bedisclosed by us in reports filed or submitted under the Securities Exchange Actof 1934 is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

***Changes in Internal Control over Financial Reporting.*** There have not been any changes in ourinternal control over financial reporting that occurred during the quarterended March 31, 2008 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II— OTHER INFORMATION**

 

**Item1.              Legal Proceedings**.

 

From time to time, wereceive threats or may be subject to routine litigation matters related to ourbusiness. However, we are not currently a party to any material pending legalproceedings.

 

**Item1A.            RiskFactors**.

 

In addition to the risk factors previously disclosedunder the heading “Risk Factors” in Part I — Item 1A of our Annual Reporton Form 10-K for the fiscal year ended December 31, 2007, filed withthe Securities and Exchange Commission on March 17, 2008, you shouldcarefully consider the risk factors described below which relate to our sale ofthe Ostoecel asset disposal group to NuVasive, Inc.  If any of the following risk factors or anyof the risk factors set forth in our Annual Report on Form 10-K for thefiscal year ended December 31, 2007 actually occur, our business,financial condition or results of operations could be materially adverselyaffected.

 

**Risk Factors Regarding theProposed Sale of the Osteocel Asset Disposal Group.**

** **

***The proposed sale may notbe completed if the conditions to closing are not satisfied or waived.***

 

The proposed sale may not be completed because theconditions to closing may not be satisfied or waived.  Conditions which must be satisfied or waivedprior to the technology assets closing include obtaining stockholder approvaland required consents from third parties such as tissue suppliers and partiesto important contracts, and the receipt of requisite approvals or theexpiration of applicable waiting periods under the Hart-Scott-Rodino AntitrustImprovements Act of 1976, as amended.  Ifthe transaction is not completed, it is possible that we will have difficultyrecouping the costs incurred in connection with negotiating the proposedtransaction, and our business may be seriously harmed.  In addition, depending upon the reason forthe termination, pursuant to the asset purchase agreement, we may becomeobligated upon termination to pay NuVasive a termination fee of $2,000,000, or$350,000 in expense reimbursements.

 

***We may not receive all ofthe payments available to us under the terms of the asset purchase agreement,and accordingly, we may have less cash available to us to fund our remainingoperation*****s.**

 

Theterms of the asset purchase agreement provide for an initial payment of $35million dollars in cash and allow for the prospect of additional milestonepayments, of up to approximately an additional $50 million dollars in theaggregate.  In addition, pursuant to theterms of a manufacturing agreement to be entered into concurrent with theinitial closing under the asset purchase agreement, we will have the ability toearn fee revenues related to the production of Osteocel for supply to NuVasiveover a period of approximately eighteen months following the initial closing ofthe transaction.  The manufacturing agreementimposes minimum purchase order obligations on NuVasive which, if satisfied byus result in potential fee revenues of approximately $52 million.  Our ability to earn these milestone paymentsor fee revenues is, however, subject to a number of conditions anduncertainties, and we have no assurances that these amounts will, in fact, bepaid to or be received by us in full.  Ifwe do not receive these payments, we will have less cash available to fund ourremaining operations and to support the continued development and pursuit ofFDA approval for our biologic drug candidates, including Prochymal.

 

***The asset purchaseagreement will expose us to contingent liabilities which could adversely affectour ability to pursue our core business focused on the development andmarketing approval for our biologic drug candidates, including Prochymal.***

 

In the asset purchase agreement we have madecustomary representations and warranties and the parties have agreed toindemnify each other for breaches of representations, warranties and covenantscontained in the asset purchase agreement, and we have agreed to indemnifyNuVasive for certain excluded liabilities. Should we incur liability for breach of these representations or warranties,our ability to pursue our core business focused on the development andmarketing approval for our biologic drug candidates, including Prochymal, couldbe materially and adversely affected.

 

***The failure to completethe proposed sale may result in a decrease in the market value of our common stockand may impair our ability to achieve our objectives of developing, obtainingFDA approval and marketing our biologic drug candidates, including Prochymal.***

 

The failure to complete the proposed sale may resultin a decrease in the market value of our common stock and may impair ourability to achieve our objectives of becoming profitable as quickly as possibleand enhancing the value of our assets to our stockholders.

 

If our stockholders fail to approve the proposedsale, or if the proposed sale is not completed for any other reason, we willnot receive the benefits of the transaction, which may substantially limit ourability to implement our strategy of pursuing the continued development, FDAapproval and marketing of our biologic drug candidates, including Prochymal.

 

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*** ***

***Bycompleting the proposed sale, we will be selling the assets that havehistorically generated substantially all of our revenue.***

** **

Pursuant to the proposed sale, we will be selling ourentire product line relating to the processing, manufacturing, marketing andselling of Osteocel and Osteocel XO. This business has historically been the source of a significantpercentage of our revenue.  Although weexpect to receive continued revenues for the supply of product pursuant to themanufacturing agreement, these revenues will not be long term and will likelycease within eighteen months after the initial closing under the asset purchaseagreement.  Although our business relatedto the development, obtaining FDA approval and marketing of our biologic drugcandidates, including Prochymal, will remain, this business has generated noappreciable revenue and has caused us to incur significant operating expensesand resulted in the incurrence of substantial losses in each year since ourinception.  We expect to continue toincur operating expenses and anticipate our expenses and losses will increasein the foreseeable future as we continue our efforts to develop, obtain FDAapproval and market our biologic drug candidates, including Prochymal.  Even in the event that all milestone paymentsare received by us under the asset purchase agreement, these funds and thefunds available under the manufacturing agreement may not collectively besufficient to fund our anticipated losses and expenses.  Accordingly, we may need to seek additionalfunding prior to our becoming cash flow positive on an operational basis.  We would likely seek such funding throughpublic or private financing or some combination of them.  Additional funding may not be available to uson acceptable terms, or at all.

 

***Our long term businessprospects will depend primarily on the success of our biologic drug candidatesbusiness.***

 

Although we will continue to manufacture Osteocelfor approximately eighteen months after the initial closing under the assetpurchase agreement, our biologic drug candidate business will be the primaryfocus of our business.  Our long termbusiness prospects will, therefore, be dependent almost solely on the successof our biologic drug candidate business. This business is based on novel technologies and involves significantrisks and challenges in regards to product development and optimization,manufacturing, government regulation, intellectual property, third-partyreimbursement and market acceptance, among other risks previously disclosed byus.

 

**Item2.              Unregistered Sales of Equity Securities and Use of Proceeds**.

 

**NoteConversion**

 

In January 2008, weinduced the conversion of $1.2 million of our 10% convertible promissorynotes, together with accrued interest, into 89,380 shares of common stock atthe conversion price of $14.00 per share. The notes were held by institutionaland accredited investors based outside of the U.S.    Thedebt conversion was arranged for us by Friedli Corporate Finance, Inc., ofwhich Peter Friedli, our Chairman of the Board of Directors and largestshareholder, is President and sole owner. The securities issued as a result of the debt conversion were issuedpursuant to exemptions from registration, as provided for under Regulation Sand Regulation D promulgated under Securities Act of 1933, as amended. In January 2008,we filed a Registration Statement on Form S-3 to register the resale ofthese shares by the respective holders.

 
| **Item 3.** | **Defaults  Upon Senior Securities**.                     |
|-------------|-----------------------------------------------------------|
|        |                                                      |
|        | None.                                                     |
|        |                                                      |
| **Item 4.** | **Submission  of Matters to a Vote of Security Holders**. |
|        |                                                      |
|        | None.                                                     |
|        |                                                      |
| **Item 5.** | **Other  Information**.                                   |
|        |                                                      |
|        | None.                                                     |
|        |                                                      |
| **Item 6.** | **Exhibits**.                                             |

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                    |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                |       | Form of Subscription  Agreements, entered into on March 19 and March 24, 2008, by a  between the Registrant and certain non-U.S. Purchasers in connection with the  issuance and sale of $8.0 million in Convertible Promissory Notes in the  aggregate. |
|                |       |                                                                                                                                                                                                                                                                    |
| 10.2                |       | Form of 2%  Convertible Promissory Notes of the Registrant, dated March 19 and March 24,  2008, issued in the aggregate principal amount of $8 million to certain  non-U.S. Purchasers.                                                                  |
|                |       |                                                                                                                                                                                                                                                                    |
| 31.1                |       | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) and  15D-14(a) under the Securities Exchange Act of 1934, as amended (Section 302  of the Sarbanes-Oxley Act of 2002).                                                      |
|                |       |                                                                                                                                                                                                                                                                    |
| 31.2                |       | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and  15D-14(a) under the Securities Exchange Act of 1934, as amended (Section 302  of the Sarbanes-Oxley Act of 2002).                                                      |
|                |       |                                                                                                                                                                                                                                                                    |
| 32                  |       | Certification of Principal Executive Officer and Principal Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                      |

 

17

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The certification attachedas Exhibit 32 that accompanies this Quarterly Report on Form 10-Q isnot deemed filed with the Securities and Exchange Commission and is not to beincorporated by reference into any filing of Osiris Therapeutics, Inc.under the Securities Act of 1933, as amended, or the Securities Exchange Act of1934, as amended, whether made before or after the date of this QuarterlyReport on Form 10-Q, irrespective of any general incorporation languagecontained in such filing.

 

**SIGNATURE**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                    |   | **Osiris Therapeutics, Inc.** |
|-------------------------|--------|------------------------------------|
|                    |   |                               |
| Date: May 12, 2008 |   | /s/ PHILIP R. JACOBY, JR.          |
|                    |   | Philip R. Jacoby, Jr.         |
|                    |   | Interim Chief Financial Officer    |

 

18

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