Table of Contents

** **

 

** **

**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, 2009**                                                                                                                                                                                                                         |
| ** **                                                                                                                                                                                                                                                                      | ** ** | ** **                                                                                              |
| **or**                                                                                                                                                                                                                                                                          |
| ** **                                                                                                                                                                                                                                                                      | ** ** | ** **                                                                                              |
| **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.) |
|                                                            |       |                                  |
| **7015  Albert Einstein Drive, Columbia, Maryland**             | ** ** | **21046**                             |
| (Address of principal  executive 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 mark whether theregistrant has submitted electronically and posted on its corporate Web site,if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  Yes o No o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See definitions of “large accelerated filer,” “acceleratedfiler,” 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 7, 2009** |
|-------------------------------------------|------------|----------------------------------------------------|
| Common Stock, par value  $0.001 per share |       | 32,715,357                                         |

 

 

 

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Table of Contents

 

**OSIRIS THERAPEUTICS, INC.**

 

**INDEX**

 
| ** **                                    | ** **                                                                                                 | ** ** | **Page**   |
|-----------------------------------------------|------------------------------------------------------------------------------------------------------------|------------|------------|
| **PART I —  FINANCIAL INFORMATION** |                                                                                                       | 3          |
| ** **                                    | ** **                                                                                                 | ** ** | ** ** |
| Item 1.                                       | Financial  Statements — Unaudited                                                                     |       | 3          |
|                                          | Condensed  Balance Sheets — March 31, 2009 and December 31, 2008                            |       | 3          |
|                                          | Condensed  Statements of Operations — three months ended March 31, 2009 and 2008                 |       | 4          |
|                                          | Condensed  Statement of Stockholders’ Equity (Deficit) — three months ended  March 31, 2009 |       | 5          |
|                                          | Condensed  Statements of Cash Flows — three months ended March 31, 2009 and 2008                 |       | 6          |
|                                          | Notes to Condensed Financial Statements                                                                    |       | 7          |
|                                          |                                                                                                       |       |       |
| Item 2.                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                |       | 17         |
|                                          |                                                                                                       |       |       |
| Item 3.                                       | Quantitative  and Qualitative Disclosures About Market Risk                                                |       | 25         |
|                                          |                                                                                                       |       |       |
| Item 4.                                       | Controls and  Procedures                                                                                   |       | 25         |
|                                          |                                                                                                       |       |       |
| **PART II  — OTHER INFORMATION**    |                                                                                                       | 26         |
|                                          |                                                                                                       |       |       |
| Item 1.                                       | Legal Proceedings                                                                                          |       | 26         |
| Item 1A.                                 | Risk Factors                                                                                               |       | 26         |
| Item 2.                                       | Unregistered  Sales of Equity Securities and Use of Proceeds                                               |       | 26         |
| Item 3.                                       | Defaults  Upon Senior Securities                                                                           |       | 26         |
| Item 4.                                       | Submission  of Matters to a Vote of Security Holders                                                       |       | 26         |
| Item 5.                                       | Other Information                                                                                          |       | 26         |
| Item 6.                                       | Exhibits                                                                                                   |       | 26         |
|                                          |                                                                                                       |       |       |
| Signatures                                    |                                                                                                       |       | 27         |
|                                          |                                                                                                       |       |       |
| Exhibit Index                            |                                                                                                       |       |       |

 

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**PART I — FINANCIAL INFORMATION**

 

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

 

**OSIRISTHERAPEUTICS, INC.**

**CondensedBalance Sheets**

**Amountsin thousands**

 
| ** **                                                                                                     | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                     | ** ** | **Unaudited**            | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                     |       |                     |       |                        |       |
| Current assets:                                                                                                |       |                     |       |                        |       |
| Cash                                                                                                           |       | $                        | 5,426      |                        | $          | 940 |   |
| Investments available for sale                                                                                 |       | 49,584                   |       | 61,298                      |       |
| Accounts receivable                                                                                            |       | 79,727                   |       | 61,287                      |       |
| Prepaid expenses and other current assets                                                                      |       | 1,805                    |       | 2,060                       |       |
| Current assets of discontinued operations                                                                      |       | 7,336                    |       | 3,223                       |       |
| Total current assets                                                                                           |       | 143,878                  |       | 128,808                     |       |
|                                                                                                           |       |                     |       |                        |       |
| Property and equipment, net                                                                                    |       | 4,005                    |       | 394                         |       |
| Restricted cash                                                                                                |       | 666                      |       | 130                         |       |
| Other assets                                                                                                   |       | 459                      |       | 615                         |       |
| Long-term assets of discontinued operations                                                                    |       | —                   |       | 7,520                       |       |
| Total assets                                                                                                   |       | $                        | 149,008    |                        | $          | 137,467 |   |
|                                                                                                           |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                        |       |                     |       |                        |       |
| Current liabilities:                                                                                           |       |                     |       |                        |       |
| Accounts payable and accrued expenses                                                                          |       | $                        | 12,973     |                        | $          | 10,513 |   |
| Deferred revenue, current portion                                                                              |       | 40,480                   |       | 40,471                      |       |
| Capital lease obligations, current portion                                                                     |       | 7                        |       | 6                           |       |
| Current liabilities of discontinued operations                                                                 |       | 7,862                    |       | 7,219                       |       |
| Total current liabilities                                                                                      |       | 61,322                   |       | 58,209                      |       |
|                                                                                                           |       |                     |       |                        |       |
| Deferred revenue, net of current portion                                                                       |       | 74,173                   |       | 84,275                      |       |
| Other long-term liabilities                                                                                    |       | 2,466                    |       | 3                           |       |
| Total liabilities                                                                                              |       | 137,961                  |       | 142,487                     |       |
|                                                                                                           |       |                     |       |                        |       |
| Stockholders’ equity (deficit):                                                                           |       |                     |       |                        |       |
| Common stock, $.001 par value, 90,000 shares authorized 32,712 and  32,676 shares outstanding in 2009 and 2008 |       | 33                       |       | 33                          |       |
| Additional paid-in-capital                                                                                     |       | 271,107                  |       | 269,830                     |       |
| Accumulated other comprehensive income                                                                         |       | 64                       |       | 33                          |       |
| Accumulated deficit                                                                                            |       | (260,157                 | )          | (274,916                    | )          |
| Total stockholders’ equity (deficit)                                                                      |       | 11,047                   |       | (5,020                      | )          |
| Total liabilities and stockholders’ equity (deficit)                                                      |       | $                        | 149,008    |                        | $          | 137,467 |   |

 

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

 

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**OSIRISTHERAPEUTICS, INC.**

**CondensedStatements of Operations**

**Unaudited**

**Amountsin thousands, except per share data**

 
| ** **                                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
|                                                                                   |       |                                                 |       |   |   |
| **Revenue from collaborative research agreements,  government contract and royalties** |       | $                                                    | 12,726     |   | $ | 362 |   |
|                                                                                   |       |                                                 |       |   |   |
| **Operating expenses:**                                                                |       |                                                 |       |   |   |
| Research and development                                                               |       | 18,567                                               |       | 16,694 |   |
| General and administrative                                                             |       | 2,913                                                |       | 2,608 |   |
|                                                                                   |       | 21,480                                               |       | 19,302 |   |
|                                                                                   |       |                                                 |       |   |   |
| **Loss from operations**                                                               |       | (8,754                                               | )          | (18,940 | ) |
|                                                                                   |       |                                                 |       |   |   |
| **Interest income (expense), net**                                                     |       | 98                                                   |       | (209 | ) |
|                                                                                   |       |                                                 |       |   |   |
| Loss from continuing operations, before income taxes                                   |       | (8,656                                               | )          | (19,149 | ) |
|                                                                                   |       |                                                 |       |   |   |
| Income tax benefit                                                                     |       | 748                                                  |       | — |   |
| **Loss from continuing operations**                                                    |       | (7,908                                               | )          | (19,149 | ) |
|                                                                                   |       |                                                 |       |   |   |
| **Discontinued operations:**                                                           |       |                                                 |       |   |   |
| Income from operations of discontinued operations, net of income  taxes                |       | 1,239                                                |       | 3,549 |   |
| Gain from sale of discontinued operations, net of income taxes                         |       | 21,428                                               |       | — |   |
| **Income from discontinued operations**                                                |       | 22,667                                               |       | 3,549 |   |
|                                                                                   |       |                                                 |       |   |   |
| **Net income (loss)**                                                                  |       | $                                                    | 14,759     |   | $ | (15,600 | ) |
|                                                                                   |       |                                                 |       |   |   |
| **Basic and diluted earnings (loss) per share:**                                       |       |                                                 |       |   |   |
| Loss from continuing operations                                                        |       | $                                                    | (0.24      | ) | $ | (0.60 | ) |
| Income from discontinued operations                                                    |       | 0.69                                                 |       | 0.11 |   |
| Basic and diluted earnings (loss) per share                                            |       | $                                                    | 0.45       |   | $ | (0.49 | ) |
|                                                                                   |       |                                                 |       |   |   |
| Weighted Average Common Shares, basic                                                  |       | 32,692                                               |       | 31,741 |   |

 

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

 

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**OSIRISTHERAPEUTICS, INC.**

**CondensedStatement of Stockholders’ Equity (Deficit)**

**For thethree months ended March 31, 2009**

**Unaudited**

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

 
| ** **                                                                      | ** ** | ** **            | ** ** | ** **              | ** ** | ** **               | ** ** | **Accumulated** | ** ** | ** **                    | ** ** | ** **                | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|--------------------------|------------|-----------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                                                                      | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Other  Comprehensive** | ** ** | **Accumulated** | ** ** | **Total  Stockholders’** | ** ** |
| ** **                                                                      | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**              | ** ** | **Income**      | ** ** | **Deficit**                   | ** ** | **Equity (Deficit)** | ** ** |
| **Balance at January 1, 2009**                                             |       | 32,675,920            |       | $                       | 33         |                     | $          | 269,830         |       | $                             | 33         |                      | $          | (274,916 | ) | $ | (5,020 | ) |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Exercise of options to purchase common stock ($0.40 - $13.33 per  share)   |       | 14,313                |       | —                  |       | 134                      |       | —          |       | —                        |       | 134                       |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Issuance of common stock for services rendered by directors ($18.60  per share) |       | 21,500                |       | —                  |       | 400                      |       | —          |       | —                        |       | 400                       |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Share-based payment — employee compensation                                |       | —                |       | —                  |       | 743                      |       | —          |       | —                        |       | 743                       |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| **Comprehensive Income:**                                                       |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Net income for the period                                                       |       | —                |       | —                  |       | —                   |       | —          |       | 14,759                        |       | 14,759                    |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Unrealized gain on investments available for sale                               |       | —                |       | —                  |       | —                   |       | 31              |       | —                        |       | 31                        |       |
| **Total Comprehensive Income**                                                  |       |                  |       |                    |       |                     |       |            |       |                          |       | 14,790                    |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| **Balance at March 31, 2009**                                              |       | 32,711,733            |       | $                       | 33         |                     | $          | 271,107         |       | $                             | 64         |                      | $          | (260,157 | ) | $ | 11,047 |   |

 

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

 

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**OSIRISTHERAPEUTICS, INC.**

**CondensedStatements of Cash Flows**

**Unaudited**

**Amountsin thousands**

 
| ** **                                                                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
|                                                                                                     |       |                                                 |       |   |   |
| **Cash flows from operating activities:**                                                                |       |                                                 |       |   |   |
| **Continuing Operations:**                                                                               |       |                                                 |       |   |   |
| Loss from continuing operations                                                                          |       | $                                                    | (7,908     | ) | $ | (19,149 | ) |
| **Adjustments to reconcile loss from continuing  operations to net cash used in continuing operations:** |       |                                                 |       |   |   |
| Depreciation and amortization                                                                            |       | 127                                                  |       | 481 |   |
| Non cash share-based payments                                                                            |       | 1,018                                                |       | 650 |   |
| Non cash interest expense                                                                                |       | —                                               |       | 146 |   |
| **Changes in operating assets and liabilities:**                                                         |       |                                                 |       |   |   |
| Accounts receivable                                                                                      |       | 246                                                  |       | 189 |   |
| Prepaid expenses and other current assets                                                                |       | 254                                                  |       | 250 |   |
| Other assets                                                                                             |       | 156                                                  |       | 279 |   |
| Accounts payable and accrued expenses                                                                    |       | 1,796                                                |       | 1,895 |   |
| Deferred revenue                                                                                         |       | (10,092                                              | )          | — |   |
| Net cash used in continuing operations                                                                   |       | (14,403                                              | )          | (15,259 | ) |
| **Discontinued Operations:**                                                                             |       |                                                 |       |   |   |
| Income from discontinued operations                                                                      |       | 22,667                                               |       | 3,549 |   |
| **Adjustments to reconcile income to net cash  provided by discontinued operations:**                    |       |                                                 |       |   |   |
| Gain from sale of discontinued operations, net of non-cash charges                                       |       | (14,121                                              | )          | — |   |
| Depreciation and amortization                                                                            |       | 210                                                  |       | 42 |   |
| Non cash share-based payments                                                                            |       | 125                                                  |       | 25 |   |
| **Changes in operating assets and liabilities:**                                                         |       |                                                 |       |   |   |
| Accounts receivable                                                                                      |       | (17,214                                              | )          | 369 |   |
| Inventory and other current assets                                                                       |       | 1,707                                                |       | (574 | ) |
| Accounts payable and accrued expenses                                                                    |       | 4,261                                                |       | 516 |   |
| Net cash (used in) provided by discontinued operations                                                   |       | (2,365                                               | )          | 3,927 |   |
| Net cash used in operating activities                                                                    |       | (16,768                                              | )          | (11,332 | ) |
|                                                                                                     |       |                                                 |       |   |   |
| **Cash flows from investing activities:**                                                                |       |                                                 |       |   |   |
| Purchases of property and equipment                                                                      |       | (35                                                  | )          | (1,077 | ) |
| Proceeds from the sale of property and equipment                                                         |       | 17                                                   |       | — |   |
| Proceeds from sale of discontinued operations, net of transaction  costs                                 |       | 9,870                                                |       | — |   |
| Proceeds from sale of investments available for sale                                                     |       | 11,806                                               |       | 10,353 |   |
| Net cash provided by investing activities                                                                |       | 21,658                                               |       | 9,276 |   |
|                                                                                                     |       |                                                 |       |   |   |
| **Cash flows from financing activities:**                                                                |       |                                                 |       |   |   |
| Principal payments on capital lease obligations and notes payable                                        |       | (2                                                   | )          | (1,932 | ) |
| Restricted cash                                                                                          |       | (536                                                 | )          | — |   |
| Proceeds from convertible and short-term notes payable                                                   |       | —                                               |       | 8,000 |   |
| Proceeds from issuance of common stock                                                                   |       | 134                                                  |       | 3 |   |
| Net cash (used in) provided by financing activities                                                      |       | (404                                                 | )          | 6,071 |   |
|                                                                                                     |       |                                                 |       |   |   |
| Net increase in cash                                                                                     |       | 4,486                                                |       | 4,015 |   |
| Cash at beginning of period                                                                              |       | 940                                                  |       | 704 |   |
|                                                                                                     |       |                                                 |       |   |   |
| **Cash at end of period:**                                                                               |       | $                                                    | 5,426      |   | $ | 4,719 |   |

 

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

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTESTO UNAUDITED CONDENSED FINANCIAL STATEMENTS**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

**1.**    **Nature of Business**

 

Osiris Therapeutics, Inc. (“we,” “our,” or the “Company”)is a Delaware corporation headquartered in Columbia, Maryland. We beganoperations on December 23, 1992. We are a stem cell therapeutic companyfocused on developing and marketing products to treat medical conditions in theinflammatory, orthopedic, and cardiovascular areas. Our biologic drugcandidates utilize adult human mesenchymal stem cells, or MSCs, which canselectively differentiate, based on the tissue environment, into various tissuelineages, such as muscle, bone, cartilage, marrow stroma, tendon or fat. Inaddition, MSCs have anti-inflammatory properties and can prevent fibrosis orscarring, which gives MSCs the potential to treat a wide variety of medicalconditions. Our operations consist primarily of research, development andclinical activities to bring our biologic drug candidates to the marketplace.We have several research collaboration agreements and a government contract foradditional product development.

 

**2.**    **Significant Accounting Policies andRecent Accounting Pronouncements**

 

***Unaudited InterimFinancial Statements***

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States for interim financial information andwith the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States for completefinancial statements. In the opinion of management, these statements includeall adjustments (consisting of normal recurring adjustments) considerednecessary to present a fair statement of our results of operations, financialposition and cash flows. Operating results for any interim period are notnecessarily indicative of the results that may be expected for the full year.This Quarterly Report on Form 10-Q should be read in conjunction with ourfinancial statements and footnotes included in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2008.

 

***Use of Estimates***

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes.  Due to theinherent uncertainty involved in making those assumptions, actual results coulddiffer from those estimates.  We believe that the most significant estimatesthat affect our financial statements are those that relate to revenuerecognition associated with our collaborative agreements, deferred tax assets,and share-based compensation.

 

***RevenueRecognition***

 

We generate revenues from collaborative agreements,research licenses, and a government contract. Our revenue recognition policiesare in accordance with the Securities and Exchange Commission’s (“SEC”) StaffAccounting Bulletin No. 101, “*RevenueRecognition in Financial Statements*,” as amended by SEC StaffAccounting Bulletin No. 104, “*RevenueRecognition*.”

 

Revenues from collaboration agreements are evaluatedunder Emerging Issues Task Force (“EITF”) Issue No. 07-01, “*Accounting for Collaboration Agreements*.”Management evaluates revenues from agreements that have multiple elements todetermine whether the components of the arrangement represent separate units ofaccounting as defined in EITF Issue No. 00-21, “*Revenue Arrangements with Multiple Deliverables”.* Torecognize a delivered item in a multiple element arrangement, EITF Issue No. 00-21requires that the delivered items have value to the customer on a stand alonebasis, that there is objective and reliable evidence of fair value of theundelivered items and that delivery or performance is probable and within our controlfor any delivered items that have aright of return. The determination of whether multiple elements of acollaboration agreement meet the criteria for separate units of accountingrequires us to exercise our judgment.

 

Revenues from research licenses and governmentcontracts are recognized as earned upon either the incurring of reimbursableexpenses directly related to the particular research plan or the completion ofcertain development milestones as defined within the terms of the agreement.Payments received in advance of research performed are designated as deferredrevenue. Non-refundable upfront license fees and certain other related fees arerecognized on a straight-line basis over the development periods of thecontract deliverables. Fees associated with substantive at risk performancebased milestones are recognized as revenue upon their completion, as defined inthe respective agreements. Incidental assignment of technology rights isrecognized as revenue as it is earned and received.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

In October 2008, we entered into aCollaboration Agreement with Genzyme Corporation (“Genzyme”) for thedevelopment and commercialization of our biologic drug candidates, Prochymal® and Chondrogen®. Under the agreement, Genzyme is obligated to pay to usnon-contingent, non-refundable cash payments totaling $130.0 million, with$75.0 million paid during November 2008 and $55.0 million to bepaid on July 1, 2009. The agreement provides Genzyme with certain rightsto intellectual property developed by us, and requires that we continue toperform certain development work related to the subject biologic drugcandidates. Management has evaluated the deliverables related to these paymentsunder EITF Issue No. 00-21, and concluded that the various deliverablesrepresent a single unit of accounting. For this reason, we have deferred therecognition of revenue related to the upfront payments, and are amortizingthese amounts to revenue on a straight-line basis over the estimated deliveryperiod of the required development services, which extend through the firstquarter of 2012. Accordingly, we recognized $10.0 million of revenue inthe first quarter of 2009 related to the amortization of the upfront payments.The balance of these payments has been recorded as $40.0 million ofcurrent deferred revenue and $73.3 million of long term deferred revenueas of March 31, 2009. The agreement also provides for contingent milestonepayments of up to $1.25 billion in the aggregate, as well as royalties tobe paid to us on any sales by Genzyme. Consistent with our revenue recognitionpolicies, we will recognize revenue from these contingent milestone paymentsfor which we have no continuing performance obligations upon achievement of therelated milestone. For any milestone payments for which we have a continuingperformance obligation, the milestone payments will be deferred and recognizedas revenue over the term of the related performance obligations.

 

In 2007, we partnered with Genzyme to developProchymal as a medical countermeasure to nuclear terrorism and otherradiological emergencies. In January 2008, we were awarded a contract fromthe United States Department of Defense (“DoD”) pursuant to which we areseeking in partnership with Genzyme to develop and stockpile Prochymal for therepair of gastrointestinal injury resulting from acute radiation exposure. Webegan recognizing revenue under this contract during the first quarter of 2008.Contract revenue is recognized as the related costs are incurred, in accordancewith the terms of the contract. We recognized $2.6 million in revenue fromthe DoD contract during the first quarter of 2009 and $0.3 million in revenueduring the first quarter of 2008.

 

In October 2007, we entered into acollaborative agreement with the Juvenile Diabetes Research Foundation (“JDRF”)to conduct a Phase II clinical trial evaluating Prochymal as a treatmentfor type 1 diabetes mellitus. This collaborative agreement provides forJDRF to provide up to $4.0 millionof contingent milestone funding to support the development of Prochymalfor the preservation of insulin production in patients with newly diagnosedtype 1 diabetes mellitus. The contingent milestone payments under theagreement are amortized to revenue on a straight line basis over the durationof our obligations under the collaborative agreement as they are earned. Wereceived $2.0 million of the contingent milestones during 2008 and expectto receive the remaining $2.0 million in 2009. We began amortizing the$2.0 million of funding received, resulting in $0.1 million ofrevenue during the first quarter of 2009 under the agreement with JDRF. Theremaining deferred revenue under this agreement has been recorded as$0.5 million of current deferred revenue and $0.8 million of long termdeferred revenue as of March 31, 2009.

 

We have also entered into several strategicagreements with other pharmaceutical companies focusing on the development andcommercialization of our stem cell drug products. For example, in 2003, weentered into an agreement with JCR Pharmaceuticals Co., Ltd. (“JCR”)pertaining to our hematologic malignancies (GvHD) drugs for distribution inJapan.

 

We also earn royalties on the sale of humanmesenchymal stem cells sold for research purposes and recognize the revenue onthese sales as the sales are made. Our overall revenues include $66,000 and$52,000 of such royalty revenue during the first quarter of 2009 and 2008,respectively.

 

***Research andDevelopment Costs***

 

We expense internal and external research and development(“R&D”) costs, including costs of funded R&D arrangements and themanufacture of clinical batches of our biologic drug candidates used inclinical trials, in the period incurred.

 

***Income (Loss) perCommon Share***

 

Basic income (loss) per common share is calculated bydividing net income (loss) by the weighted average number of common sharesoutstanding during the period.  Diluted loss per common share adjustsbasic loss per share for the potentially dilutive effects of common shareequivalents, using the treasury stock method.  All common shareequivalents resulting from assumed exercise of outstanding stock options andwarrants are excluded from the computation of diluted loss per share as theireffect is anti-dilutive.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

***InvestmentsAvailable for Sale and Other Comprehensive Income (Loss)***

 

Investments available for sale consist primarily ofmarketable securities with maturities varying between three months and oneyear. Investments available for sale are valued at their fair value, withunrealized gains and losses reported as a separate component of stockholders’equity in accumulated other comprehensive income. Gains or losses oninvestments available for sale are reclassified to earnings when realized.

 

Investments available for sale are evaluatedperiodically to determine whether a decline in their value is “other thantemporary.” The term “other than temporary” is not intended to indicate apermanent decline in value. Rather, it means that the prospects for near termrecovery of value are not necessarily favorable, or that there is a lack ofevidence to support fair values equal to, or greater than, the carrying valueof the security. Management reviews criteria such as the magnitude and durationof the decline, as well as the reasons for the decline, to predict whether theloss in value is other than temporary. If a decline in value is determined tobe other than temporary, the value of the security is reduced and acorresponding charge to earnings is recognized.

 

***Share-BasedCompensation***

 

In December 2004, the Financial AccountingStandards Board (“FASB”), issued Statement No. 123(R) “*Share-Based Payment*,”which is a revision of Statement No. 123, *“Accounting for Stock Issued to Employees*.”Effective January 1, 2006, we adopted Statement No. 123(R) usingthe modified prospective method under which prior period amounts are notrestated for comparative purposes. Under the modified prospective method, werecognized compensation cost for:

 

·                                          all share-based payments granted after January 1,2006 based upon the requirements of Statement No. 123(R); and

 

·                                          all unvested awards granted prior to January 1,2006 using the compensation cost calculated for pro forma disclosure purposesunder Statement No. 123.

 

Under Statement No. 123(R), we have recognizedall share-based payments to employees and non-employee directors in ourfinancial statements based on their grant date fair values, calculated usingthe Black-Scholes option pricing model. Compensation expense related toshare-based awards is recognized on a straight-line basis based on the value ofshare awards that are expected to vest during the requisite service period.Under Statement No. 123(R), share-based compensation expense is based onawards ultimately expected to vest and must be reduced for estimatedforfeitures.

 

A summary of the combined activity under both of ourstock-based compensation plans as of March 31, 2009 and changes during thethree months then ended is presented below.

 
| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price Per Share  at Grant Date** | ** ** | **Weighted Average  Remaining Term  (in Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | ** **                 | ** ** | ** **                                                                                  | ** ** | ** **                                                      | ** ** | **($000)**                          | ** ** |
| Outstanding at December 31, 2008 |       | 1,211,177                  |       | $                                                                                           | 10.66      |                                                            | 8.02       |                                | $          | 10,592 |   |
| Granted at market value               |       | 143,000                    |       | 18.48                                                                                       |       |                                                            |       |                                |       |
| Exercised                             |       | (14,313                    | )          | 9.36                                                                                        |       |                                                            |       | 146                                 |       |
| Forfeited or expired                  |       | (66,821                    | )          | 12.73                                                                                       |       |                                                            |       |                                |       |
| Outstanding at March 31, 2009    |       | 1,273,043                  |       | 11.45                                                                                       |       | 7.88                                                            |       | 5,552                               |       |
|                                  |       |                       |       |                                                                                        |       |                                                            |       |                                |       |
| Exercisable at March 31, 2009    |       | 524,097                    |       | 6.30                                                                                        |       | 6.4                                                             |       | 4,660                               |       |
|                                       |            |                            |            |                                                                                             |            |                                                                 |            |                                     |            |  |  |

 

The weighted average grant date fair value of optionsgranted during the three months ended March 31, 2009 was $8.87 pershare.  We received a total of $134,000 in cash from the exercise ofoptions during the three months ended March 31, 2009.

 

Also during the three months ended March 31,2009, we granted 21,500 unrestricted shares of common stock to members of ourBoard of Directors under our Amended and Restated 2006 Omnibus Plan andrecognized $400,000 in share-based expense.  As of March 31, 2009,468,327 shares of common stock remain available for future grants under ourAmended and Restated 2006 Omnibus Plan.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

Share-based compensation expense (including directorcompensation) included in our statements of operations for the three monthsended March 31, 2009 and 2008 is allocable to our research and developmentactivities, discontinued operations and general and administrative activities,as follows:

 
| ** **                 | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|
| ** **                 | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
| ** **                 | ** ** | **($000)**                                           | ** ** | **($000)** | ** ** |
| Research and development   |       | $                                                    | 244        |   | $ | 229 |   |
| Discontinued operations    |       | 125                                                  |       | 25 |   |
| General and administrative |       | 774                                                  |       | 421 |   |
| Total                      |       | $                                                    | 1,143      |   | $ | 675 |   |

 

As of March 31, 2009, there was approximately$4.3 million of total unrecognized share-based compensation cost related tooptions granted under our plans, which will be recognized over aweighted-average period of approximately 3 years.

 

***Supplemental CashFlow Information***

 

| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                                                                 | ** ** | **($000)**                                       | ** ** | **($000)** | ** ** |
| **Supplemental disclosure of cash flows  information:**                    |       |                                             |       |   |   |
| Cash paid for interest                                                     |       | $                                                | 4          |   | $ | 208 |   |
| Cash paid for income taxes                                                 |       | —                                           |       | — |   |
| **Supplemental schedule of non-cash investing and  financing activities:** |       |                                             |       |   |   |
| Common stock issued to directors for services rendered                     |       | 400                                              |       | 228 |   |
|                                                                            |            |                                                  |            |  |  |  |  |

 

***Significant NewAccounting Pronouncements***

 

In April 2009, the FASB issued FASB StaffPosition No. FAS 107-1 and APB 28-1, “*InterimDisclosures about Fair Value of Financial Instruments*,” whichrequires disclosures about fair value of financial instruments for interimreporting periods of publicly traded companies as well as in annual financialstatements. This Staff Position is effective for interim reporting periodsending after June 15, 2009, with early adoption permitted for periodsending after March 15, 2009. We have adopted this Staff Position as ofJanuary 1, 2009 and the required disclosures are included in this QuarterlyReport on Form 10-Q.

 

In April 2009, the FASB issued FASB StaffPosition No. FAS 115-2 and FAS 124-2, “*Recognitionand Presentation of Other-Than-Temporary Impairments*,” which amendsthe other-than-temporary impairment guidance in U.S. GAAP for debt securitiesto make the guidance more operational and to improve the presentation anddisclosure of other-than-temporary impairments on debt and equity securities inthe financial statements. This Staff Position is effective for interim andannual reporting periods ending after June 15, 2009, with early adoptionpermitted for periods ending after March 15, 2009. The adoption of thisStaff Position did not have a material effect on our operations.

 

In April 2009, the FASB issued FSP No. FAS 157-4, “D*etermining Fair Value When the Volume and Level ofActivity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly*. “ This FSPprovides additional guidance for estimating fair value in accordance with SFASNo. 157, Fair Value Measurements, when the volume and level of activity for theasset or liability have significantly decreased. This FSP also includesguidance on identifying circumstances that indicate a transaction is notorderly. This FSP emphasizes that even if there has been a significant decreasein the volume and level of activity for the asset or liability and regardlessof the valuation technique(s) used, the objective of a fair value measurementremains the same. Fair value is the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction (that is, not aforced liquidation or distressed sale) between market participants at themeasurement date under current market conditions. The FSP is effective for usin the second quarter of 2009 and is not expected to have a material effect onour financial position or results of operations.

 

**3.    Collaboration Agreements and Government Contract**

 

Below is a discussion of each of our materialcollaborative agreements and contracts. This discussion is qualified in itsentirety by the actual terms and provisions of the respective agreements andcontracts. The accounting policies related to each of these contracts,including material impact on our financial statements, is included above underthe “Revenue Recognition” section of Note 2, Significant AccountingPolicies and Recent Accounting Pronouncements.

 

***CollaborationAgreement with Genzyme Corporation***  On October 31, 2008, we entered into a CollaborationAgreement with Genzyme for the development and commercialization of Prochymaland Chondrogen. Under the terms of the agreement, we will retain the rights tocommercialize Prochymal and Chondrogen in the United States and Canada, andGenzyme has been granted the exclusive right and license to commercializeProchymal and Chondrogen in all other countries (the “Genzyme Territory”),except with respect to Prochymal for Graft vs. Host Disease (“GvHD”) in Japan,which has previously been licensed to another pharmaceutical company. Genzymehas the right to “opt-out” of any further Chondrogen development followingreceipt of the results of the planned Phase II/III clinical trial forChondrogen.  If Genzyme opts-out, allrights to Chondrogen will revert to us with no further obligations between thecompanies with regard to****Chondrogen.  In the event that Genzyme does not opt-outbut instead participates in the future development efforts for Chondrogen, theywould be entitled to retain rights and licenses to our intellectual propertyrelated to Chondrogen in all countries outside the United States and Canada.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

As partial consideration for the grant of theserights, the Collaboration Agreement provides for a non-contingent,non-refundable cash payment to us of $130.0 million from Genzyme, with$75.0 million paid in November 2008 and $55.0 million scheduledto be paid on July 1, 2009. The Collaboration Agreement also provides forcontingent milestone payments of up to $1.25 billion in the aggregate, inaddition to royalties on any sales by Genzyme, to be paid by Genzyme to us, asfollows:

 

*Prochymal:*     As respectsProchymal, we are eligible to receive up to $500.0 million in developmentand regulatory milestone payments and up to $250.0 million in sales basedmilestone payments, as follows:

 

·                                          Total development milestones related to GvHD of up to$50.0 million, with $25.0 million payable upon marketing approvalfrom the United States Food & Drug Administration (“FDA”), and$25.0 million payable upon marketing approval from the European MedicinesAgency (“EMEA”).

 

·                                          Total development milestones of up to$180.0 million related to Crohn’s disease and Ulcerative Colitis,with $50.0 million payable upon achieving statistically significantendpoint(s) in a Phase III clinical trial for Crohn’s disease,$100.0 million payable upon marketing approval by the EMEA for Crohn’sdisease, $10.0 million payable upon achieving statistically significantendpoint(s) in a Phase II or Phase III clinical trialfor Ulcerative Colitis, and $20.0 million payable upon achievingmarketing approval for Ulcerative Colitis by the EMEA.

 

·                                          Total development milestones of up to$270.0 million related to the development of follow-on indications forProchymal, with $20.0 million payable upon each success in a Phase IIclinical trial for acute myocardial infarction, type 1 diabetes or otherfollow-on indications, as agreed to by the Company and Genzyme, and$40.0 million payable upon receipt of each marketing approval by the EMEAfor Prochymal for chronic obstructive pulmonary disease (“COPD”), acutemyocardial infarction, type 1 diabetes mellitus or other follow-onindications, as agreed to by the Company and Genzyme.

 

·                                          Total sales based milestones of up to$250.0 million for Prochymal, with $100.0 million payable when annualProchymal sales reach $500.0 million in the Genzyme Territory, and$150.0 million payable when annual Prochymal sales reach $1.0 billionin the Genzyme Territory.

 

*Chondrogen:*     Upon receipt of theresults of the planned Phase II/III clinical trial of Chondrogen, Genzymemay elect to opt-out of any further Chondrogen development, at which point allrights to Chondrogen will revert to us with no further obligations between thecompanies with regard to****Chondrogen.If Genzyme does not opt-out, we are eligible to receive up to$500.0 million in development, regulatory and sales based milestonepayments for Chondrogen, as follows:

 

·                                          Total development and regulatory milestones of up to$100.0 million, with $10.0 million payable if Genzyme does notopt-out, $10.0 million payable upon demonstration of disease modificationin the current clinical trial program, $40.0 million payable uponmarketing approval by either the FDA or EMEA for a pain reduction indication,and $40.0 million payable upon marketing approval by either the FDA orEMEA for a disease modification indication.

 

·                                          Total sales milestones of up to $400.0 million,with $100.0 million payable when annual Chondrogen sales reach$500.0 million in the Genzyme Territory, $150.0 million payable whenannual Chondrogen sales reach $1.0 billion in the Genzyme territory, and$150.0 million payable when annual Chondrogen sales reach $2.0 billionin the Genzyme Territory.

 

We will be solely responsible for ongoing clinicaltrial costs and future clinical trial costs with respect to both Prochymal andChondrogen through Phase II clinical trials. We will share with Genzymeall costs of future Phase III and Phase IV clinical trials foragreed-upon indications (assuming in the case of Chondrogen that Genzyme doesnot opt-out), with us being responsible for 60% of such costs and Genzymeresponsible for 40% of such costs.

 

Assuming successful development and marketingapproval (and, assuming in the case of Chondrogen that Genzyme does notopt-out), we will be entitled toreceive escalating royalties on sales of Prochymal and Chondrogen within theGenzyme Territory.

 

***GenzymePartnership and the United States Department of Defense Contract.***    In 2007, we partnered with Genzyme to develop Prochymalas a medical countermeasure to nuclear terrorism and other radiologicalemergencies. In January 2008, we were awarded a contract from the DoDpursuant to which we, in partnership with Genzyme, are seeking to develop andstockpile Prochymal for the repair of gastrointestinal injury resulting fromacute radiation exposure. Under the terms of the contract, the DoD will providefunding to us for the development of Prochymal for acute radiation syndrome (“ARS”).If we are successful in obtaining FDA approval for ARS, the contract providesfor the purchase by the DoD of up to 20,000 doses of Prochymal, at $10,000 perdose, in four 5,000 dose increments. Under the terms of our partnership withGenzyme, we contribute Prochymal and corresponding safety and efficacy data tothe effort and Genzyme lends its vast product development and large-scalecommercialization expertise. The agreement provides for Genzyme to receive aroyalty of 15% on sales of Prochymal, limited to those sales made undercontract to U.S. or allied governmental agencies for emergency preparedness.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

***Juvenile DiabetesResearch Foundation Agreement.***     In 2007, we entered into a collaborativeagreement with the JDRF which provides funding to support the development ofProchymal as a treatment for the preservation of insulin production in patientswith newly diagnosed type 1 diabetes mellitus. This collaborativeagreement provides for JDRF to provide up to $4.0 million of contingentmilestone funding. We initiated a Phase II clinical trial evaluatingProchymal as a treatment for type 1 diabetes in the fourth quarter of2007, and received $2.0 million of the contingent milestones during 2008and expect to receive the remaining $2.0 million of contingent milestonesby 2010. Consistent with our revenue recognition policies for such contingentmilestones, upon its receipt we began amortizing the $2.0 million receivedduring 2008 and will continue to amortize that amount over the remaining termof our obligations under the agreement.

 

***JCRPharmaceuticals Agreement.***     In 2003, we entered into a strategic alliancewith JCR. Under the JCR agreement, we have granted JCR the exclusive right inJapan to use our technology in conjunction with the treatment of hematologicmalignancies using hematopoietic stem cell transplants. The JCR agreemententitles us to a licensing fee and to royalties on any resulting revenue. Uponcommencement of the agreement, JCR purchased 545,454 shares of our Series BConvertible Preferred Stock for $3.0 million. These shares were convertedinto 136,363 shares of our common stock concurrent with our initial publicoffering in August 2006. JCR has also paid us a total of $4.0 millionin licensing fees under the agreement.

 

**4.**    **Discontinued Operations &Gain on Sale of Discontinued Operations**

 

On May 8, 2008, we entered into an AssetPurchase Agreement to sell our Osteocel® business to NuVasive, Inc., aDelaware corporation.  Osteocel is a product that we developed and that wemanufactured beginning in July 2005, for regenerating bone in orthopedicindications. The agreement provided for the sale to be effected at two closings—a technology assets closing, at which technology and certain other businessassets are transferred, and a manufacturing assets closing, at whichmanufacturing assets and facilities are transferred.  On July 24,2008, we held a Special Meeting of Stockholders at which our stockholdersoverwhelmingly approved the sale of the Osteocel business.  The technologyassets closing also occurred on that date, at which time we received an initialpayment of $35.0 million. In December 2008, we earned another $5.0 millionin additional purchase price through the achievement of a production milestone.The agreements with NuVasive were amended several times during 2008, allwithout altering the potential purchase price of up to $85.0 million.

 

In March 2009, we entered into further amendmentsto the Asset Purchase Agreement and the related Manufacturing Agreement, as aresult of which the manufacturing assets closing was accelerated and allperformance conditions to receipt by us of $30.0 million of contingent milestonepayments were removed.  As a result,those payments became payable at specified dates, without regard to otherconditions.  A final milestone payment of$15.0 million remains conditioned on at least $35.0 million in cumulativeOsteocel sales by NuVasive.

 

The Asset Purchase Agreement, as amended, provides forup to $85.0 million of total purchase price, as follows:

 
| **Payments**                                                                                                     | ** ** | **Amount** | ** ** | **Payment Date**             | ** **     |
|------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------------------------|----------------|
| ** **                                                                                                       | ** ** | **($000)** | ** ** | ** **                   | ** **     |
| Initial Payment                                                                                                  |       | $          | 35,000     |                         | July 2008 |   |
| Cumulative sales to NuVasive of 75,000 ccs of Osteocel                                                           |       | 5,000      |       | Paid  in January 2009   |           |
| Accelerated Manufacturing Assets Closing                                                                         |       | 5,000      |       | Paid  March 2009        |           |
| Installment payment in cash or stock                                                                             |       | 12,500     |       | Due  June 30, 2009      |           |
| Installment payment in cash or stock                                                                             |       | 12,500     |       | Due  September 30, 2009 |           |
| Contingent milestone payment due upon NuVasive achieving at least  $35.0 million in cumulative sales of Osteocel |       | 15,000     |       | Upon  achievement            |           |
|                                                                                                             |       |       |       |                         |           |
| Total possible purchase  price                                                                                   |       | $          | 85,000     |                         |           |   |

 

The $30.0 million of payments that became payable atspecified dates as a result of the March 2009 amendments, net of directexpenses of approximately $0.2 million, were recorded as a component of thegain on the sale of discontinued operations in the first quarter of 2009.  If and when the requisite events related tothe final $15.0 million contingent milestone occur, we will recognize themilestone proceeds as a component of gain (loss) from the sale of discontinuedoperations. Title to the fixed assets to be transferred to NuVasive passed onApril 9, 2009, and was recorded as assets of discontinued operations held forsale in the accompanying condensed balance sheet.

 

Concurrent with the March 2009 amendments, weexecuted a Supply Agreement with AlloSource to facilitate the complete transferof the Osteocel business, whereby we would transfer to AlloSource our entire Osteocelwork-in-process inventory at specified prices on the date of the manufacturingassets closing with NuVasive.  Theaggregate purchase price for the Osteocel work-in-process inventory isapproximately $3.7 million, payable by AlloSource in cash installments over the90-days following the execution of the Supply Agreement. The sale of thework-in-process inventory to AlloSource occurred on April 9, 2009, and wasrecorded as assets of discontinued operations held for sale in the accompanyingcondensed balance sheet.

 

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** **

**OSIRIS THERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

As stipulated under the March 2009 amendments, weceased manufacturing Osteocel on March 28, 2009.    As a result of this cessation ofmanufacturing, we committed to a workforce reduction of the approximately80-employees involved in the Osteocel business.  Employees directlyaffected by the workforce reduction received notification on March 30,2009, and we expect the workforce reduction to be substantially completed inthe second quarter of 2009.  All of the affected employees receivedseverance benefits, comprised principally of severance, benefits continuationcosts and outplacement services.  Totalone-time termination benefits for the reduction in force totaled approximately$1.4 million, which was recorded as a component of the gain on the sale ofdiscontinued operations in the first quarter of 2009.

 

Also in connection with the March 2009amendments, we relieved NuVasive of its obligation to assume the lease for ourColumbia, Maryland facility.  As a resultof the combination of our cessation of Osteocel manufacturing and retaining thelease obligations for the Columbia, Maryland facility, we have conducted ananalysis of our future minimum lease payments for the facility in accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 146, “*Accounting for Costs Associated with Exit or DisposalActivities*” and recorded an impairment charge of approximately $3.2million related to our future minimum lease payments.  Additionally, we recorded an impairment ofthe leasehold improvements specifically related to Osteocel production ofapproximately $3.0 million.  Both ofthese impairments were recorded as components of the gain on the sale ofdiscontinued operations in the first quarter of 2009.

 

Also as a result of acceleration of the manufacturingassets closing, during the first quarter of 2009 we reversed approximately $2.5million of concessionary pricing reserves for future Osteocel production thathad been established under the original Manufacturing Agreement.

 

The fair value of the property that we transferred onthe date of the manufacturing assets closing, including both the manufacturingassets transferred to NuVasive and the inventory transferred to AlloSource, wasapproximately $5.1 million.

 

As detailed above, we recognized a pre-tax gain ofapproximately $23.5 million on the sale of discontinued operations during thefirst quarter of 2009.  Net of taxes, thegain on the sale was approximately $21.4 million during the quarterly periodending March 31, 2009.

 

In connection with this transaction, we recognized again on the sale of discontinued operations of $30.4 million during the fiscalyear ended December 31, 2008, as detailed in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2008.

 

We eliminated the Osteocel asset disposal group fromour ongoing operations as a result of the disposal transaction and havepresented the group’s assets, liabilities, and the results of the group’soperations as a discontinued operation for all periods.

 

The net assets allocable to the Osteocel assetdisposal group included on our balance sheet at March 31, 2009 and December 31,2008 were as follows:

 

| ** **                                          | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                          | ** ** | **($000)** | ** ** | **($000)** | ** ** |
| Accounts receivable                                 |       | $          | 2,280      |       | $          | 1,516 |   |
| Inventory                                           |       | —     |       | 1,502      |       |
| Assets held for sale                                |       | 5,056      |       | —     |       |
| Other current assets                                |       | —     |       | 205        |       |
|                                                |       |       |       |       |       |
| Current assets of discontinued operations           |       | 7,336      |       | 3,223      |       |
|                                                |       |       |       |       |       |
| Property and equipment, net                         |       | —     |       | 7,520      |       |
|                                                |       |       |       |       |       |
| Liabilities of discontinued operations              |       | (7,862     | )          | (7,219     | )          |
|                                                |       |       |       |       |       |
| Net assets (liabilities) of discontinued operations |       | $          | (526       | )          | $          | 3,524 |   |

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

Summarized operating results of the Osteocel assetdisposal group are as follows:

 

| ** **                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                              | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **                                                              | ** ** | **($000)**                                       | ** ** | **($000)** | ** ** |
| Product sales                                                           |       | $                                                | 6,267      |   | $ | 7,511 |   |
| Cost of goods sold                                                      |       | 4,787                                            |       | 3,781 |   |
| Gross profit                                                            |       | 1,480                                            |       | 3,730 |   |
|                                                                    |       |                                             |       |   |   |
| Selling, general & administrative expenses                     |       | 124                                              |       | 181 |   |
| Income from operations of discontinued operations, before income  taxes |       | 1,356                                            |       | 3,549 |   |
| Income taxes                                                            |       | 117                                              |       | — |   |
| Income from operations of discontinued operations, net of tax           |       | $                                                | 1,239      |   | $ | 3,549 |   |

 

**5.****                                     ****Earnings (Loss) PerCommon Share**

 

Basicearnings (loss) per common share is based on the weighted average number ofshares of common stock outstanding during the period. Dilutive shares arecomputed using the treasury stock method and include the incremental effect ofshares that would be issued upon the assumed exercise of stock options andwarrants. Common stock equivalents have not been included in the calculation ofdiluted loss from continuing operations per share for the three months ended March 31,2009 and 2008 since their impact on the calculation would be anti-dilutive.

 

**6.****                                     ****Income Tax (Benefit) Expense**

 

The tax benefit for thequarter ended March 31, 2009 reflects an effective tax rate for continuingoperations of 8.6% compared to a U.S. statutory tax rate of 35%.  Theeffective tax rate reflects our estimated annual effective tax rate, whichreflects our expectation that a portion of our income will be subject to theFederal alternative minimum tax in 2009. During the quarterly period ended March 31, 2009, we recognized thefollowing income tax expense (benefit):

 
| ** **                                             | ** ** | **March 31, 2009** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **($000)**              | ** ** |
| Tax benefit to continuing operations                   |       | $                       | (748       | ) |
| Tax expense from operations of discontinued operations |       | 117                     |       |
| Tax expense sale of discontinued operations            |       | 2,027                   |       |
|                                                   |       |                    |       |
| Total income tax expense                               |       | $                       | 1,396      |   |

 

We have not recognizedany deferred tax assets or liabilities in our financial statements since wecannot assure their future realization. Because realization of deferred tax assets is dependent upon futureearnings, a full valuation allowance has been recorded on the net deferred taxassets, which relate primarily to net operating loss and research anddevelopment carry-forwards.  In the eventthat we become profitable within the next several years, we have net deferredtax assets of approximately $102.5 million that may be utilized prior to ushaving to recognize any income tax expense or make payments to the taxingauthorities.  However, utilization of ournet operating loss and tax credit carry-forwards in any one year may be limitedunder Internal Revenue Code Sections 382 and 383. In addition, even if certainof our net deferred tax assets are not subject to limitations, we may besubject to the Federal alternative minimum tax in future years.

 

**7.**                                      **Fair Value**

 

Fair value is defined as the price at which an assetcould be exchanged or a liability transferred (an exit price) in an orderlytransaction between knowledgeable, willing parties in the principal or mostadvantageous market for the asset or liability. Where available, fair value isbased on observable market prices or parameters or derived from such prices orparameters. Where observable prices or inputs are not available, valuationmodels are applied. At March 31, 2009, dilutive common stock equivalentsexcluded from the calculation of basic loss from continuing operations pershare were 560,633 shares related to in-the-money stock options and 410,219shares related to our outstanding warrant.

 

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** **

**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

Financial assets recorded at fair value in theaccompanying financial statements are categorized based upon the level ofjudgment associated with the inputs used to measure their fair value.Hierarchical levels, defined by SFAS No. 157 “*Fair Value Measurements”*and directly related to the amountof subjectivity associated with the inputs to fair valuation of these assetsand liabilities, are as follows:

 
| *Level 1* |   | Inputs are unadjusted, quoted prices in active  markets for identical assets at the reporting date. Active markets are those  in which transactions for the asset or liability occur in sufficient  frequency and volume to provide pricing information on an ongoing basis.                                                                                                                                                  |
|----------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| * *       |   |                                                                                                                                                                                                                                                                                                                                                                                                                          |
|           |   | The fair valued assets we hold that are generally  included in this category are money market securities where fair value is  based on publicly quoted prices.                                                                                                                                                                                                                                                                |
|           |   |                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *Level 2* |   | Inputs are other than quoted prices included in  Level 1, which are either directly or indirectly observable for the  asset or liability through correlation with market data at the reporting date  and for the duration of the instrument’s anticipated life.                                                                                                                                                     |
| * *       |   |                                                                                                                                                                                                                                                                                                                                                                                                                          |
|           |   | The fair valued assets we hold that are generally  included in this category are investment grade short-term securities.                                                                                                                                                                                                                                                                                                      |
|           |   |                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *Level 3* |   | Unobservable inputs that are supported by little or  no market activity and that are significant to the fair value of the assets  or liabilities and which reflect management’s best estimate of what market  participants would use in pricing the asset or liability at the reporting  date. Consideration is given to the risk inherent in the valuation technique  and the risk inherent in the inputs to the model. |
| * *       |   |                                                                                                                                                                                                                                                                                                                                                                                                                          |
|           |   | We carry no investments classified as Level 3                                                                                                                                                                                                                                                                                                                                                                            |

 

Assets and liabilities measured at fair value on arecurring basis are summarized below:

 
| ** **                            | ** ** | **March 31, 2009  ($000)** | ** ** | **December 31, 2008  ($000)** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **Level 1**                     | ** ** | **Level 2**                        | ** ** | **Total** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Total** | ** ** |
| Assets:                               |       |                            |       |                               |       |   |   |   |   |   |   |   |   |
| Overnight securities included in Cash |       | $                               | 5,403      |                               | $          | — |   | $ | 5,403 |   | $ | 929 |   | $ | — |   | $ | 929 |   |
| Investments available for sale        |       | 49,584                          |       | —                             |       | 49,584 |   | 61,298 |   | — |   | 61,298 |   |
| Short-term assets held for Sale       |       | —                          |       | 5,056                              |       | 5,056 |   | — |   | — |   | — |   |
|                                  |       |                            |       |                               |       |   |   |   |   |   |   |   |   |
| Total assets                          |       | $                               | 54,987     |                               | $          | 5,056 |   | $ | 60,044 |   | $ | 62,227 |   | $ | — |   | $ | 62,227 |   |

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS****(continued)**

**THREE MONTHS ENDED MARCH 31,2009 AND 2008**

 

Investments available for sale consisted of thefollowing as of March 31, 2009 and December 31, 2008:

 
| ** **                                            | ** ** | **March 31, 2009****($000)** | ** ** | **December 31, 2008****($000)** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------|------------|
| ** **                                            | ** ** | **Cost**                          | ** ** | **Fair Value**                       | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| **Cash equivalents:**                                 | ** ** | ** **                        | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Money market funds & certificates of deposit |       | $                                 | 23,378     |                                 | $          | 23,379 |   | $ | 33,436 |   | $ | 33,436 |   |
| Commercial paper                                      |       | —                            |       | —                               |       | 11,187 |   | 11,195 |   |
|                                                  |       | 23,378                            |       | 23,379                               |       | 44,623 |   | 44,631 |   |
| **Short term investments:**                           | ** ** | ** **                        | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Auction rate certificates                             |       | —                            |       | —                               |       | 3,100 |   | 3,100 |   |
| Corporate notes and bonds                             |       | 4,391                             |       | 4,386                                |       | 1,921 |   | 1,921 |   |
| US government agencies                                |       | 21,751                            |       | 21,819                               |       | 11,621 |   | 11,646 |   |
|                                                  |       | 26,142                            |       | 26,205                               |       | 16,642 |   | 16,667 |   |
|                                                  |       |                              |       |                                 |       |   |   |   |   |
| **Total investments available for sale**              | ** ** | **$**                             | **49,520** | ** **                           | **$**      | **49,584** | ** ** | **$** | **61,265** | ** ** | **$** | **61,298** | ** ** |
|                                                  |       |                              |       |                                 |       |   |   |   |   |
| ** **                                            | ** ** | **Cost**                          | ** ** | **Fair Value**                  | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| **Maturities:**                                       | ** ** | ** **                        | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Within 3-months                                       |       | $                                 | 21,676     |                                 | $          | 21,627 |   | $ | 46,826 |   | $ | 46,832 |   |
| Between 3—12 months                         |       | 16,770                            |       | 16,916                               |       | 10,208 |   | 10,190 |   |
| Between 1—2 years                           |       | 11,074                            |       | 11,041                               |       | 4,231 |   | 4,276 |   |
| **Total investments available for sale**              | ** ** | **$**                             | **49,520** | ** **                           | **$**      | **49,584** | ** ** | **$** | **61,265** | ** ** | **$** | **61,298** | ** ** |

 

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**Item2.****   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

**Forward-LookingInformation**

 

This Quarterly Report includes “forward-lookingstatements” within the meaning of Section 21E of the Securities ExchangeAct of 1934, or the Exchange Act. Forward-looking statements include statementsconcerning our plans, objectives, goals, strategies, future events, futurerevenues or performance, capital expenditures, compensation arrangements,financing needs, plans or intentions relating to acquisitions, business trendsand other information that is not historical information and, in particular,may appear under the headings “Risk Factors” in our Annual Report on Form 10-Kunder Part I—Item 1A, “Part II—Item 7.  Management’s Discussionand Analysis of Financial Condition and Results of Operations” and the otherdocuments we file with the United States Securities and Exchange Commission, orSEC, including, among others, this and other of 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 orsimilar expressions are intended to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to,statements regarding the following: our product development efforts; ourclinical trials and anticipated regulatory requirements; the success of ourproduct candidates in development; status of the regulatory process for ourbiologic drug candidates; implementation of our corporate strategy; ourfinancial performance; our product research and development activities and projectedexpenditures, including our anticipated timeline and clinical strategy formesenchymal stem cells and biologic drug candidates (including the anticipatedtimeline and clinical strategy for Prochymal and Chondrogen); our cash needs;patents and proprietary rights; ability of our potential products to treatdisease; our plans for sales and marketing; our plans regarding facilities;types of regulatory frameworks we expect will be applicable to our potentialproducts; results of our scientific research; our ability to benefit from thesale of our Osteocel business and to earn milestone payments; and our abilityto benefit from our collaborations with Genzyme and other collaborations and toearn milestone payments and perform under and derive royalty and other revenuethereunder.  Risks and uncertainties related to the sale of our Osteocelassets and related transactions include typical business trancactional risks,the risk of changing relationships with customers, suppliers or employees; andthe risk that we may not be able to fully perform or generate or receivecontingent milestone payments. Risks and uncertainties related to ourCollaboration Agreement with Genzyme for the development and commercializationof Prochymal and Chondrogen include, among others:  typical businesstransactional risks; risks related to product development and clinical trialdesign, performance and completion; uncertainty of the success of Prochymal andChondrogen in clinical trials and their ability to treat disease; Genzyme’s earlytermination and opt-out rights; the ability of Osiris and Genzyme tosuccessfully navigate regulatory requirements and to manufacture andcommercialize products; and the uncertainty as to our ability to successfullyperform under the collaborative arrangement and earn milestone and royaltypayments thereunder.  All forward-looking statements, including, withoutlimitation, management’s examination of historical operating trends, are basedupon our current expectations and various assumptions.  Our expectations,beliefs and 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 or projections will result or be achieved and you shouldnot unduly rely on forward-looking statements.

 

You should read the following management’s discussionand analysis of our financial condition and results of operations inconjunction with our audited Financial Statements and related notes thereto andother disclosures included as part of our Annual Report on Form 10-K forthe year ended December 31, 2008, and our unaudited Condensed FinancialStatements for the three months ended March 31, 2009 and other disclosuresincluded in this Quarterly Report on Form 10-Q.  Our CondensedFinancial Statements have been prepared in accordance with U.S. generallyaccepted accounting principles and are presented in U.S. dollars.

 

There are a number of risks and uncertainties thatcould cause our actual results to differ materially from the forward-lookingstatements contained in this report. Some of the important factors that couldcause our actual results to differ materially from the forward-lookingstatements we make in this report are set forth in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2008 under Part I — Item 1A “RiskFactors.” There may be other factors that may cause our actual results todiffer materially from the forward-looking statements.

 

All forward-looking statements attributable to us or personsacting on our behalf apply only as of the date of this Quarterly Report and areexpressly qualified in their entirety by the cautionary statements includedherein.  We undertake no obligation to publicly update or revise anyforward-looking statements to reflect subsequent events or circumstances and donot intend to do so.

 

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

 

**Introductionand Overview**

 

The following is a discussion and analysis of ourfinancial condition and results of operations for the three month periods endedMarch 31, 2009 and 2008.  You should read this discussion togetherwith the accompanying unaudited condensed financial statements and notes andwith our Annual Report on Form 10-K for the year ended December 31,2008.  Historical results and any discussion of prospective results maynot indicate our future performance.  See “Forward Looking Information.”

 

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We are a stem cell therapeutic company headquarteredin Columbia, Maryland, focused on developing and marketing products to treatmedical conditions in the inflammatory, orthopedic, and cardiovascularareas.  We were incorporated in Delaware in April 2002.  Ourpredecessor company was organized in 1992.  Our lead biologic drugcandidate, Prochymal®, is being evaluated in Phase III clinical trials forthree indications, including acute and steroid refractory GvHD and Crohn’sdisease, and is the only stem cell therapeutic currently granted both OrphanDrug and Fast Track status by the U.S. Food and Drug Administration (“FDA”). Prochymal is also being developed for the repair of heart tissue following aheart attack, the protection of pancreatic islet cells in patients withtype 1 diabetes mellitus, and the treatment of patients with COPD. Our pipeline of internally developed biologic drug candidates under evaluation alsoincludes Chondrogen for osteoarthritis in the knee.

 

As discussed more fully in Note 3 to the accompanyingCondensed Financial Statements, on October 31, 2008, we entered into aCollaboration Agreement with Genzyme Corporation (“Genzyme”) for the globaldevelopment and commercialization of our biologic drug candidates, Prochymaland Chondrogen.  Under the terms of the Collaboration Agreement, we retainthe right to commercialize Prochymal and Chondrogen in the United States andCanada, and Genzyme is granted the exclusive right and license to commercializethe products in all other countries (except with respect to GvHD in Japan whereProchymal has previously been licensed to another pharmaceutical company). In July 2007,we separately partnered with Genzyme for the development of effectivecountermeasures to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the U.S. Department ofDefense (“DoD”), pursuant to which we are seeking, in partnership with Genzyme,to develop and stockpile Prochymal for the repair of gastrointestinal injuryresulting from acute radiation exposure.   Additionally, we havepartnered with the Juvenile Diabetes Research Foundation (“JDRF”) for thedevelopment of Prochymal as a treatment for the preservation of insulinproduction in patients with newly diagnosed type 1 diabetes mellitus.

 

In April 2008, we committed to a plan to sell ourassets related to Osteocel, a product that we produced and marketed beginningin July 2005, for regenerating bone in orthopedic indications.  On May 8,2008, we entered into an Asset Purchase Agreement to sell those assets,including our entire product line relating to the processing, manufacturing,marketing and selling of Osteocel and Osteocel XO, to NuVasive, Inc. The first of two scheduled closings in connection with this transaction, the “technologyassets closing”, occurred on July 24, 2008, at which time we received aninitial payment of $35.0 million.  Concurrent with the technology assets closing,we entered into a Manufacturing Agreement with NuVasive, under which wecontinued to manufacture Osteocel until March 28, 2009 when allmanufacturing activities ceased. In March 2009, we entered into amendmentsto the Asset Purchase Agreement and amendments to the related ManufacturingAgreement that stipulated that all of our responsibilities would be consideredfulfilled upon consummation of the second and final closing, the “manufacturingassets closing.” The manufacturing assets closing occurred on April 9,2009.  Upon execution of the amendments, we received $5.0 million ofadditional purchase price in cash and will receive an additional $12.5 millionin either cash or NuVasive stock on each of June 30, 2009 and September 30,2009 (for an aggregate of $25.0 million in cash or stock).  We are also entitled to receive a contingentmilestone payment of $15.0 million if and when NuVasive achieves cumulativesales revenue from Osteocel of at least $35.0 million.  We presently expect to earn this contingentmilestone before the end of the current fiscal year, although no assurance canbe given that this will occur.

 

We are a fully integrated company, having developedcapabilities in research, development, manufacturing, marketing anddistribution of stem cell products. We have developed an extensive intellectualproperty portfolio to protect our technology in the United States and a numberof foreign countries, including 48 U.S. and 284 foreign patents owned orlicensed.  We believe that our biologic drug candidates have advantagesover other stem cell therapeutics in development for at least the followingreasons:

 

·                                          **Stem Cell Source.**   Our stem cells are obtainedfrom adult bone marrow, a readily available source. The cells are drawn fromthe hips of volunteer donors between the ages of 18 and 30 years, using asimple needle and syringe aspiration. Because the cells are obtained fromconsenting adult donors, we are able to largely avoid the ethical controversysurrounding embryonic and fetal stem cell research.

 

·                                          **Ability to Mass Produce.**   Through our proprietarymanufacturing methods, we can grow mesenchymal stem cells (“MSCs”) in acontrolled fashion to produce up to 10,000 treatments of our biologic drugcandidates from a single bone marrow donation. Our ability to produce a largequantity of treatments from one donation provides us with manufacturingefficiencies and product consistency that are essential to commercialization.

 

·                                          **Universal Compatibility.**   Many stem cell therapiesunder development can elicit a rejection response in the recipient andtherefore require donor-to-recipient matching or potentially harmfulimmunosuppression. This greatly reduces manufacturing efficiencies and createsa risk of mismatch which can result in an acute inflammatory response and,potentially, in death.Based on our clinical experience, we believe that our biologic drugcandidates are not rejected by the patient’s immune system and so, liketype O negative blood, do not require donor-to-recipient matching. Thisuniversal compatibility allows us to produce a standardized product availableto all patients in almost any medical setting.

 

·                                          **Treatment on Demand.**   Our biologic drug candidatescan be stored frozen at end-user medical facilities until they are needed. Weanticipate that medical facilities will be able to prescribe and dispense theseproducts in much the same way as conventional drugs. In contrast, other stemcell technologies under development require weeks to prepare after a patient’sneed is identified. This is a key feature of our technology, as many patientsin the critical care setting require prompt treatment.

 

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The following table summarizes key information aboutour 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 Mellitus                  |       | Phase II                |
|                  |       | Acute Myocardial Infarction                    |       | Phase II                |
|                  |       | Chronic Obstructive Pulmonary Disease          |       | Phase II                |
|                  |       | Acute Radiation Syndrome                       |       | Phase III (Animal Rule) |
|                  |       |                                           |       |                         |
| **Chondrogen**        |       | Osteoarthritis & Cartilage Protection |       | Phase II                |

 

***Prochymal*** is our lead biologic drug candidate andis being evaluated in Phase III clinical trials for four indications, includingthe first line treatment of acute GvHD, steroid refractory acute GvHD,biologics refractory Crohn’s disease, and acute radiation syndrome, and is theonly stem cell therapeutic currently designated by the FDA as both an OrphanDrug and Fast Track product.

 

*Phase III ClinicalTrial—Steroid Refractory Acute GvHD*

 

GvHD is a life threatening immune system reaction thatcommonly affects the skin, gastrointestinal tract, and liver in patients whohave received a bone marrow transplant.   Our Phase IIItrial to evaluate Prochymal as a treatment for steroid refractory GvHD is arandomized, double blind, placebo controlled study. The trial has completedenrollment with a total of 244 patients. The trial is investigating patientresponse to eight infusions of Prochymal administered twice per week for fourconsecutive weeks. The primary trial endpoint is complete resolution of GvHDfor at least 28 day duration. Each patient will also be monitored forsafety for up to 180 days after their first treatment with Prochymal.Six-month survival is a key secondary endpoint. This trial is being conductedin 72 centers in the United States, Canada, Europe and Australia.

 

*Phase III Clinical Trial—FirstLine Treatment of Acute GvHD.*

 

In April 2008, we completed enrollment in aPhase III trial evaluating Prochymal as an add-on therapy to steroids forthe first-line treatment of acute GvHD.   This randomized,double blind, placebo controlled study has completed enrollment with a total of192 patients. The trial is investigating patient response to a total of sixinfusions during the first four weeks of the study. The primary trial endpointis the proportion of patients who achieve a complete response at day 28 and whosurvive to day 90 without the addition of a second line therapy. The study isbeing conducted at approximately 50 centers in the United States andCanada.

 

*Phase III Clinical Trial—BiologicsRefractory Crohn’s Disease.*

 

Based on our clinical observations of the effects ofProchymal on the gastrointestinal symptoms of patients with GvHD, we aredeveloping Prochymal for the treatment of Crohn’s disease. Crohn’s disease is achronic condition that results in inflammation of the gastrointestinal tract.We completed patient enrollment in a Phase II trial for Crohn’s diseaseunder an Investigational New Drug (“IND”) exemption for Crohn’s disease. Wereceived Fast Track designation from the FDA for the development of Prochymalfor patients with moderate to severe Crohn’s disease that is refractory tostandard therapies, including biologics.

 

On March 27, 2009, we announced that we had elected to end enrollmentat 210 patients in our Phase III clinical trial evaluating Prochymal for the treatment of moderate to severe Crohn’sdisease that is refractory to biological therapy and immunosuppressives.  We ended enrollment because webelieve that there was a design flaw in the trial resulting in significantlyhigher than expected placebo response rates.  The decision was made afterthe trial’s final scheduled interim analysis showed that one of the twoProchymal dose arms had crossed a futility boundary.  The dose arm wasunlikely to achieve the primary endpoint of remission because of the highplacebo response rate.  This analysis continued to show no serious safetyconcerns with the therapy and safety was not a factor in the decision to stopenrollment.   After careful discussionwith the United States Food and Drug Administration, we elected to discontinueenrollment rather than attempt to re-power the trial.  We will keep thetrial blinded and expect data for use in designing future trials in Crohn’sdisease and to bolster Prochymal’s overall safety database.   TheProchymal Crohn’s program consisted of two separate but related trials. The first trial, described above, evaluates patients’ initial response to twodose levels of Prochymal as compared to placebo.  This trial wasoriginally designed to enroll 270 subjects.  Patients responding to theinitial therapy were then eligible to participate in a second, longer-termtrial evaluating Prochymal as a maintenance therapy.  Because the currentstandard for determining response of Crohn’s patients is largely subjective,there may have been response bias in order to meet the eligibility requirementsfor continuation of therapy in the longer-term maintenance trial. Accordingly, enrollment in the second trial has also ended.

 

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*Phase II Clinical Trial—AcuteMyocardial Infarction.*

 

Prochymal is also being evaluated for the repair ofheart muscle in patients who have suffered a heart attack.  In February, 2009 we reported positivetwo-year data on the Phase I clinical trial for Prochymal to evaluate itssafety and efficacy to restore heart function in patients experiencing a firsttime myocardial infarction (MI). Based on these positive findings, we havereceived approval from the FDA to initiate a Phase II trial.  We recently initiated this Phase II trial, which isexpected to include approximately 220 patients to be treated at approximately40 sites in the United States and Canada. The first patient in the Phase IItrial was treated in April 2009.

 

*Phase II Clinical Trial—EarlyOnset Type 1 Diabetes.*

 

We initiated a Phase II, 60 patient, placebocontrolled study in the United States for the treatment of early onset type 1diabetes in individuals 18 to 30 years old.  Primary efficacy will be measured at oneyear—the primary endpoint is the marker of insulin response in response toglucose stimulation. We have entered into a collaborative agreement with theJuvenile Diabetes Research Foundation (“JDRF”) for this study. This agreementprovides for JDRF to fund $4.0 million of clinical study costs for 2008through 2010. During 2008, we received $2.0 million from JDRF to fundclinical costs, and expect to receive the remaining $2.0 million during2009 and 2010.

 

*Phase II Clinical Trial—ChronicObstructive Pulmonary Disease*

 

We are evaluating the safety and efficacy of Prochymalin conjunction with standard of care for improving pulmonary function inpatients with moderate to severe COPD in a Phase II clinical trial. This trialof 62 enrolled patients is a double-blind, placebo-controlled study. Patientswere randomized to either Prochymal or placebo at a 1:1 ratio and received 4infusions over the course of 90 days. Measurements used in the trial todetect potential improvements in subjects treated with Prochymal includepulmonary function tests, exercise capability, and quality of life assessments.In addition, exacerbations and hospitalizations due to COPD will be monitored forboth safety and efficacy. Patients will be evaluated over the course of twoyears following initial Prochymal or placebo infusion.

 

*Phase III Clinical Trial—AnimalRule—Acute Radiation Syndrome.*

 

In 2007, we partnered with Genzyme Corporation todevelop Prochymal as a medical countermeasure to nuclear terrorism and otherradiological emergencies. In January 2008, we wereawarded a contract from the United StatesDepartment of Defense (“DoD”) for the development and stockpiling of Prochymalfor the treatment of acute radiation syndrome (“ARS”). The fully funded valueof the contract, assuming FDA approval of Prochymal for ARS and exercise by DoDof all of its purchase options for up to 20,000 doses of Prochymal at a priceof $10,000 per dose, is up to $224.7 million. We are carrying out thiscontract in collaboration with Genzyme.

 

***Chondrogen*** is our biologic drug candidate for thetreatment of osteoarthritis and the reduction of pain in theknee.    We completed enrollment of a randomizeddouble-blind, placebo controlled Phase I/II clinical trial evaluatingChondrogen for safety and preliminary efficacy based upon regeneration ofmeniscus at six-months. In November 2007, we reported one-year data forthe Phase I/II Chondrogen trial. The data continued to show improvementsin joint condition that correlated with a clinically and statisticallysignificant improvement in pain in patients with osteoarthritis (OA) whoreceived Chondrogen as compared to those treated with the control, hyaluronicacid (HA). Patients receiving the control were 3.5 times more likely toexperience degenerative bone changes associated with OA as compared to thosereceiving Chondrogen. The effects were dose dependent and pain scores improvedfrom six months to one year following treatment, suggesting Chondrogen caused abiological modification of patients’ OA.

 

**FinancialOperations Overview**

 

*Revenue*

 

In2008, we entered into a Collaboration Agreement with Genzyme for thedevelopment and commercialization of Prochymal and Chondrogen, and providingfor non-contingent, non-refundable up front payments of $130.0 million andcontingent milestone payments. This Collaboration Agreement has multipledeliverables, and consistent with our accounting policy for such transactions,we are amortizing these amounts into revenue on a straight-line basis over theestimated completion period of the deliverables, which extend through the firstquarter of 2012. We recognized $10.0 million of revenue in the firstquarter of 2009 related to this agreement. Contingent milestone payments earnedand for which we have no continuing performance obligations, will be recognizedas revenue upon achievement of the related milestone, while milestone paymentsfor which we have a continuing performance obligation will be deferred whenreceived and amortized to revenue over the term of the related performanceobligations.

 

In 2007, we partnered with Genzyme to developProchymal as a medical countermeasure to nuclear terrorism and otherradiological emergencies. In the first quarter of 2008, we were awarded acontract from the DoD pursuant to which we are seeking in partnership withGenzyme to develop and stockpile Prochymal for the repair of gastrointestinalinjury resulting from acute radiation exposure. Under the terms of the contract,the DoD provides funding to us for development. If we are successful inobtaining FDA approval for acute radiation syndrome, the contract provides forthe purchase of up to 20,000 doses of Prochymal, at $10,000 per dose, in four5,000 dose increments. We recognized $2.5 million in revenue under theterms of this contract in the first quarter of 2009.

 

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In prior years, we have entered into strategicagreements with others for the development and commercialization of select stemcell biologic drug candidates for specific indications and geographic markets.In 2007, we entered into a collaborative agreement with the JDRF to conduct aPhase II clinical trial evaluating Prochymal as a treatment fortype 1 diabetes mellitus. Under this collaborative agreement,  JDRF will provide up to $4.0 million ofcontingent milestone funding to support the development of Prochymal for thepreservation of insulin production in patients with newly diagnosed type 1diabetes mellitus. The contingent milestone payments under the agreement areamortized into revenue on a straight line basis over the duration of ourobligations under the collaborative agreement as they are earned. We recognized$0.1 million in revenue during the first quarter of 2009 under thisagreement.

 

In 2003, we entered into an agreement with a foreignpharmaceutical company granting it exclusive rights to Prochymal for thetreatment of GvHD in Japan.

 

*Research and Development Costs*

 

Our research and development costs consist of expensesincurred in identifying, developing and testing biologic drug candidates. Theseexpenses consist primarily of salaries and related expenses for personnel, feespaid to professional service providers for independent monitoring and analysisof our clinical 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 on the development ofbiologic drug candidates with potential uses in multiple indications, many ofour costs are not attributable to a specifically identified product. We use ouremployee and infrastructure resources across several projects. Accordingly, wedo not account for internal research and development costs on aproject-by-project basis. From inception in December 1992 through March 31,2009, we incurred aggregate research and development costs of approximately$323.0 million.

 

We expect our research and development expenses tocontinue to increase in the future, as we expand our clinical trial activityfor our existing biologic drug candidates as they advance through thedevelopment cycle and as we invest in additional product opportunities andresearch programs. Clinical trials and preclinical studies are time-consumingand expensive. 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 we obtainresults from clinical trials, we may elect to discontinue or delay trials forsome biologic drug candidates in order to focus our resources on more promisingbiologic drug candidates. Completion of clinical trials may take several yearsor more, but the length of time generally varies substantially according to thetype, size of trial and intended use of a biologic drug candidate. The cost ofclinical trials may vary significantly over the life of a project as a resultof a variety of factors, including:

 

·                                          the number of patients who participate in the trials;

 

·                                          the number of sites included in the trials;

 

·                                          the length of time required to enroll trialparticipants;

 

·                                          the duration of patient treatment and follow-up;

 

·                                          the costs of producing supplies of the biologic drugcandidates needed for clinical trials and regulatory submissions;

 

·                                          the efficacy and safety profile of the biologic drugcandidate; and

 

·                                          the costs and timing of, and the ability to secure,regulatory approvals.

 

As a result of these uncertainties, we are unable todetermine with any significant degree of certainty the duration and completioncosts of our research and development projects or when and to what extent wewill generate revenues from the commercialization and sale of any of ourbiologic drug candidates.

 

*General and Administrative Expenses*

 

General and administrative expenses consist primarilyof the costs associated with our general management, including salaries,allocations of facilities and related costs, and professional fees such aslegal and accounting expenses. We have increased our general and administrativeexpense for legal and accounting compliance costs, investor relations and otheractivities associated with operating as a publicly traded company andstrengthened our administrative capabilities as we approach the commerciallaunch of Prochymal for an initial indication. Continued increases will alsolikely result from the hiring of additional operational, financial, accounting,facilities engineering and information systems personnel.

 

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* *

*Interest Income (Expense), Net*

 

Interest income consists of interest earned on ourcash and investments available for sale. Interest expense consists of interestincurred on capital leases and other debt financings. We pay interest on ourpromissory notes, capital leases and convertible long-term debt. We do notexpect to incur material interest expense in the near future as we hadextinguished all of our outstanding debt as of December 31, 2008, and haveinvested our excess cash in investments available for sale.

 

*Income Taxes*

 

During the fiscal quarter ended March 31, 2009, werecognized an income tax benefit to continuing operations of $0.7 million, andincome tax expense of $2.1 million against the income from discontinuingoperations.. We have not recognized any deferred tax assets or liabilities inour financial statements above these amounts since we cannot assure theirfuture realization.  Because realizationof deferred tax assets is dependent upon future earnings, a full valuationallowance has been recorded on the net deferred tax assets, which relateprimarily to net operating loss and research and developmentcarry-forwards.  In the event that webecome profitable within the next several years, we have net deferred taxassets of approximately $102.5 million that may be utilized prior to us having torecognize any income tax expense or make payments to the taxingauthorities.  However, utilization of ournet operating loss and tax credit carry-forwards in any one year may be limitedunder Internal Revenue Code Sections 382 and 383. In addition, even if certainof our net deferred tax assets are not subject to limitations, we may besubject to the Federal alternative minimum tax in future years.

 

The tax benefit for the quarter ended March 31,2009, reflects an effective tax rate for continuing operations of 8.6% comparedto a U.S. statutory tax rate of 35%.  The effective tax rate reflectsour estimated annual effective tax rate, which reflects our expectation that aportion of our income will be subject to the Federal alternative minimum tax in2009.

 

**Critical Accounting Policies**

 

There have been no material changes in our criticalaccounting policies, estimates and judgments during the three months ended March 31,2009 compared to the disclosures in Part II, Item 7 of our AnnualReport on Form 10-K for the year ended December 31, 2008, other thanas disclosed herein.

 

**Resultsof Operations**

 

***Comparison of Three Months Ended March 31, 2009 and2008***

 

*Revenuesfrom Continuing Operations*

 

Revenues from continuing operations were $12.7 millionfor the three months ended March 31, 2009 compared to $0.4 million for thefirst quarter of fiscal 2008.  We recognized $10.0 million in revenue fromour collaborative agreement with Genzyme and $0.1 million from ourcollaborative agreement with JDRF. Our revenues for the three month period alsoinclude $2.5 million from our contract with the DoD to develop Prochymal forthe treatment of acute radiation syndrome, plus $0.1 million in royalties onMSCs sold for research purposes.  Revenues from continuing operations forthe three months ended March 31, 2008 were $0.4 million, and consistedprimarily of the recognition of unearned revenue from a license agreement thatwas terminated in December 2007.

 

*Research and Development Expenses*

 

Research and development expenses for the three monthsended March 31, 2009 were $18.6 million, as compared to research anddevelopment expenses of $16.7 million for the same period last year.  Theincrease in these expenses compared to the prior year reflects the increase inour clinical trial activities.  At March 31, 2009, we were conductingthree Phase III clinical trials in several inflammatory disease indications,and Phase II clinical trials for acute myocardial infarction, type 1 diabetesmellitus, and COPD.  In addition, we were conducting animal studies inaccordance with the FDA Animal Rule for acute radiation syndrome. The increased clinical trial activities have increased the demand for clinicalbatches of our biologic drug candidates and we have experienced increased costsin our contract manufacturing activities.  We are also incurring researchand development expenses in connection with the preparation of our biologiclicense application as we prepare filings with the FDA towards thecommercialization of Prochymal for an initial indicaation.

 

*General and Administrative Expenses(excluding discontinued operations)*

 

General and administrative expenses were $2.9 millionfor the three months ended March 31, 2009 compared to $2.6 million for thecomparable period in fiscal 2008.  The increase in general andadministrative expenses is primarily attributable to increases in ourprofessional staff in the areas of intellectual property and businessdevelopment and increases in legal costs related to our intellectual propertyportfolio.

 

*Interest Income (Expense), Net*

 

Interest income, net was $0.1 million for the threemonths ended March 31, 2009 compared to net interest expense of $0.2million in the corresponding period in fiscal 2008.  During 2009, we havenot had any short or long-term debt, and interest expense consists of financingcharges on capital leases for equipment. We earn interest income on our investments available for sale.

 

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***Income fromOperations of Discontinued Operations***

 

Income from operations of the Osteocel asset disposalgroup was $1.2 million for the three months ended March 31, 2009 comparedto earnings of $3.5 million for the comparable period of fiscal 2008, as follows:

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **March 31,**               | ** ** |
| ** **                                                   | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| ** **                                                   | ** ** | **($000)**                       | ** ** | **($000)** | ** ** |
| Product sales                                                |       | $                                | 6,267      |   | $ | 7,511 |   |
| Cost of goods sold                                           |       | 4,787                            |       | 3,781 |   |
| Gross profit                                                 |       | 1,480                            |       | 3,730 |   |
|                                                         |       |                             |       |   |   |
| Selling, general & administrative expenses          |       | 124                              |       | 149 |   |
| Income from operations of discontinued operations before tax |       | 1,356                            |       | 3,549 |   |
| Income tax                                                   |       | 117                              |       | — |   |
| Income (loss) from operations of discontinued operations     |       | $                                | 1,239      |   | $ | 3,549 |   |

 

In April 2008, we committed to a plan to sell ourbiologic tissue business, consisting of the Osteocel asset disposalgroup.  On May 8, 2008 we entered into an Asset Purchase Agreementfor the sale of the Osteocel asset disposal group to NuVasive, Inc., andon July 24, 2008, the first of two scheduled closings, the “technologyassets closing,” occurred and we received a $35.0 million payment. Duringthe fourth quarter of 2008, we earned additional purchase price of $5.0 millionupon the achievement of production milestones. Concurrent with the technology assets closing, we entered into aManufacturing Agreement with NuVasive, under which we continued to manufactureOsteocel until March 28, 2009 when all manufacturing activities ceased. InMarch 2009, we entered into amendments to the Asset Purchase Agreement andamendments to the related Manufacturing Agreement which stipulated that, uponconsummation of the second and final closing (the “manufacturing assets closing”)under the Asset Purchase Agreement all of our responsibilities would be deemedfulfilled.  The manufacturing assetsclosing occurred on April 9, 2009.  Upon execution of the amendments,we received $5.0 million of additional purchase price in cash and are scheduledto receive an additional $12.5 million in either cash or NuVasive stock on eachof June 30, 2009 and September 30, 2009  (for a total of $25.0 million in cash orstock).  We are also entitled to receivea contingent milestone payment of $15.0 million if and when NuVasive achievescumulative sales revenue from Osteocel of at least $35.0 million.  We presently expect to earn this contingentmilestone payment prior to the end of the current fiscal year.

 

**Liquidity and Capital Resources**

 

***Liquidity***

 

The current global financial crisis — which hasincluded, among other things, significant reductions in available capital andliquidity from banks and other providers of credit, substantial reductionsand/or fluctuations in equity and currency values worldwide, significantdecreases in consumer confidence and consumer and business spending, andconcerns that the worldwide economy may enter into a prolonged recessionaryperiod — may materially adversely affect our access to capital.  Inaddition, the current global financial crisis may materially adversely affectthe liquidity and access to capital of parties with which we from time to time collaborate,which may in turn adversely impact their ability or desire to participate orperform under their collaborations with us.  These potential effects ofthe current global financial crisis are difficult to forecast and mitigate.Should additional capital be required to pursue our business plan, but not beavailable, as a result of the global economic crisis or otherwise, our businessand financial condition would be materially and adversely affected.

 

At March 31, 2009, we had $55.0 million in cashand investments available for sale and $79.7 million of short-termreceivables.  We presently estimate that we have sufficient liquidity onhand as of March 31, 2009 to fund our operations through the initialcommercialization of Prochymal for an initial indication.

 

***Cash Flows***

 

Net cash used in operating activities of continuingoperations was $14.4 million for the three months ended March 31, 2009,primarily reflecting our loss from continuing operations of $7.9 million, whichwas partially offset by $1.1 million of non-cash charges included in theloss.  Adding to our use of cash in theoperating activities of continuing operations was $7.6 million of unfavorableworking capital changes, consisting primarily of the $10.1 million of theamortization of the deferred revenue related to the Genzyme and JDRFcollaborations. During the first quarter of fiscal 2008, net cash used inoperating activities of continuing operations was $15.3 million, consisting ofour loss from continuing operations of $19.1 million, partially offset bynon-cash charges of $1.3 million and net favorable variances in working capitalof $2.6 million.

 

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Net cash used in operating activities of discontinuedoperations was $2.4 million for the three months ended March 31, 2009,which reflects the $11.2 million of unfavorable changes in working capital,partially offset by the income from discontinued operations of $22.7 million,net of the $14.1 million non-cash portion of the gain on sale.  Net cashprovided by operating activities of discontinued operations for the firstquarter of 2008 was $3.9 million, which is primarily made up of the income fromdiscontinued operations of $3.5 million and $0.3 million of favorable workingcapital changes.

 

Net cash provided by investing activities was $21.7million for the three months ended March 31, 2009, consisting of $9.9million of net proceeds from the sale of discontinued operations and $11.8million of proceeds from the sale of investments available for sale that we hadpurchased to efficiently utilize our excess cash at the end of 2008. Net cashprovided by investing activities during the first quarter of fiscal 2008 was$9.3 million, which was comprised of the sale of $10.4 million of investmentsavailable for sale, partially offset by $1.1 million of capital expendituresfor the expansion of our Columbia, Maryland manufacturing facilities that wascompleted during the third quarter of 2008.

 

Net cash used in financing activities was $0.4 millionfor the three months ended March 31, 2009, representing the increase inrestricted cash of $0.5 million offset by $0.1 million of proceeds from theexercise of stock options.  As discussed in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2008, our financial position whenentering fiscal 2009 allowed us to be involved in only minimal financingactivities during the first quarter of 2009. During the first quarter of 2008,net cash provided by financing activities was $6.1 million, which primarilyresulted from the issuance of $8.0 million of convertible and short term notespayable, partially offset by $1.9 million of scheduled payments on our debt andcapital lease obligations.

 

***Capital Resources***

 

Our future capital requirements will depend on manyfactors, including:

 

·                                          the scope and results of our research and preclinicaldevelopment programs;

 

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

 

·                                          the timing of and the costs involved in obtainingregulatory approvals for our biologic drug candidates, which could be morelengthy or complex than obtaining approval for a new conventional drug, giventhe FDA’s limited experience with late-stage clinical trials and marketingapproval for stem cell therapeutics;

 

·                                          the timing and achievement of contingent milestonepayments under the NuVasive agreement and the Genzyme collaboration agreement;

 

·                                          the costs of maintaining, expanding and protecting ourintellectual property portfolio, including possible litigation costs andliabilities; and

 

·                                          the costs of enlarging our work force consistent withexpanding our business and operations and status as a public company.

 

As of December 31, 2008, we had completelyextinguished our outstanding debt. As a result of our financial position andforecasts as of that date, we believe that we have sufficient liquidity on handto fund our operations through the initial commercialization of Prochymal foran initial indication.

 

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**Off-BalanceSheet Arrangements.**

 

We have no off-balance sheet financing arrangementsand we have not entered into any transactions involving unconsolidatedsubsidiaries or special purpose entities.

 

**Item3.**                                                           **Quantitative andQualitative Disclosures About Market Risk** .

 

Due to the short duration of our investment portfolioand the high quality of our investments, an immediate 10% change in interestrates would not have a material effect on the fair market value of ourportfolio.

 

We believe that the interest rate risk related to ouraccounts receivable is not significant.  We manage the risk associatedwith these accounts through periodic reviews of the carrying value for non-collectabilityand establishment of appropriate allowances in connection with our internalcontrols and policies.

 

We do not enter into hedging or derivative instrumentarrangements.

 

**Item4.**                                                           **Controls and Procedures.**

 

***Evaluation ofDisclosure Controls and Procedures.*** An evaluation of the effectiveness of the design andoperation of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934, as amended), as of the end of the periodcovered by this Quarterly Report on Form 10-Q was made under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer.  A control system, nomatter how well designed and operated, can provide only reasonable, notabsolute, assurance that the control system’s objectives will be met. Based upon this evaluation, our Chief Executive Officer and Chief FinancialOfficer have concluded that our disclosure controls and procedures (a) areeffective to ensure that information required to be disclosed by us in reportsfiled or submitted under the Securities Exchange Act of 1934 is timelyrecorded, processed, summarized and reported and (b) include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in reports filed or submitted under theSecurities Exchange Act of 1934 is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

 

***Changes in InternalControl over Financial Reporting.*** There have not been any changes in our internalcontrol over financial reporting that occurred during the quarter ended March 31,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 1.**                    **Legal Proceedings**.

 

From time to time, we receive threats or may besubject to routine litigation matters related to our business.  However,we are not currently a party to any material pending legal proceedings.

 

**Item 1A.**                 **Risk Factors**.

 

There have not been any material changes in the risk factors previouslydisclosed under the heading “Risk Factors” in Part I — Item 1A of ourAnnual Report on Form 10-K for the fiscal year ended December 31,2008, filed with the Securities and Exchange Commission on March 16, 2009.

 

**Item 2.**                    **Unregistered Sales of Equity Securities and Use ofProceeds**.

 

None.

 

**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                |       | Amendment No. 3 to Manufacturing Agreement,  dated as of March 25, 2009, by and between Osiris  Therapeutics, Inc. and NuVasive, Inc.                                                           |
|                |       |                                                                                                                                                                                                                |
| 10.2                |       | Amendment No. 2 to Asset Purchase Agreement,  dated as of March 25, 2009, by and between Osiris  Therapeutics, Inc. and NuVasive, Inc.                                                          |
|                |       |                                                                                                                                                                                                                |
| 10.3+               |       | Supply Agreement, dated as of March 25, 2009,  by and between Osiris Therapeutics, Inc. and AlloSource.                                                                                                   |
|                |       |                                                                                                                                                                                                                |
| 31.1.1              |       | 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). |
|                |       |                                                                                                                                                                                                                |
| 31.2.1              |       | 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). |
|                |       |                                                                                                                                                                                                                |
| 32.1                |       | 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.                  |

 

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+                                       Confidential portions omitted and filedseparately with the United States Securities and Exchange Commission pursuantto Rule 24b-2 promulgated under the Securities Exchange Act of 1934, asamended.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| ** **              | ** ** | **Osiris Therapeutics, Inc.**                        |
|-------------------------|------------|-----------------------------------------------------------|
|                    |       |                                                      |
| Date: May 11, 2009 |       | /s/ RICHARD W. HUNT                                       |
|                    |       | Richard W. Hunt                                           |
|                    |       | Chief Financial Officer (Principal Financial  Officer)    |
|                    |       |                                                      |
| Date: May 11, 2009 |       | /s/ PHILIP R. JACOBY, JR.                                 |
|                    |       | Philip R. Jacoby, Jr.                                |
|                    |       | Vice President of Finance (Principal Accounting  Officer) |

 

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