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 September 30, 2008** |
| ** **                                                 | ** **                                                                                              |
| **or**                                                     |
| ** **                                                 | ** **                                                                                              |
| **o**                                                      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                   to**

 

**Commission File Number:  001-32966**

 

**OSIRISTHERAPEUTICS, INC.**

(Exactname of registrant as 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’stelephone number, including area code)

 

**None**

(Formername, former address and former fiscal year, if changed since last report)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of 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 markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o    No  x

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| **Class**                                 | ** ** | **Outstanding at November 7,  2008** |
|-------------------------------------------|------------|-----------------------------------------------------|
| Common  Stock, par value $0.001 per share |       | 31,811,468                                          |

 

 

 

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**OSIRIS THERAPEUTICS, INC.**

 

**INDEX**

 
| **PART I —  FINANCIAL INFORMATION** | 3                                                                                                             |
|-----------------------------------------------|---------------------------------------------------------------------------------------------------------------|
| ** **                                    | ** **                                                                                                    | ** ** |
| Item 1.                                       | Financial Statements — Unaudited                                                                         | 3 |
|                                          | Condensed  Balance Sheets — September 30, 2008 and December 31, 2007                           | 3 |
|                                          | Condensed  Statements of Operations — three and nine months ended September 30,  2008 and 2007      | 4 |
|                                          | Condensed  Statement of Stockholders’ (Deficit) Equity — nine months ended  September 30, 2008 | 5 |
|                                          | Condensed  Statements of Cash Flows — nine months ended September 30, 2008 and 2007                 | 6 |
|                                          | Notes to Condensed Financial Statements                                                                       | 7 |
|                                          |                                                                                                          |   |
| Item 2.                                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                   | 15 |
|                                          |                                                                                                          |   |
| Item 3.                                       | Quantitative  and Qualitative Disclosures About Market Risk                                                   | 24 |
|                                          |                                                                                                          |   |
| Item 4.                                       | Controls and Procedures                                                                                       | 24 |
|                                          |                                                                                                          |   |
| **PART II  — OTHER INFORMATION**    | 25                                                                                                            |
|                                          |                                                                                                          |   |
| Item 1.                                       | Legal Proceedings                                                                                             | 25 |
| Item 1A.                                 | Risk Factors                                                                                                  | 25 |
| 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                                                                                             | 27 |
| Item 6.                                       | Exhibits                                                                                                      | 27 |
|                                          |                                                                                                          |   |
| Signatures                                    |                                                                                                          | 28 |
|                                          |                                                                                                          |   |
| Exhibit Index                            |                                                                                                          |   |

 

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**PART I— FINANCIAL INFORMATION**

 

**Item 1.****                             ****FinancialStatements - Unaudited**.

 

**OSIRIS THERAPEUTICS, INC.**

**Condensed Balance Sheets**

**Unaudited**

**Amounts in thousands**

 
| ** **                                                                                                     | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                     |       |                         |       |                        |       |
| Current assets:                                                                                                |       |                         |       |                        |       |
| Cash                                                                                                           |       | $                            | 5,300      |                        | $          | 704 |   |
| Investments available for sale                                                                                 |       | 5,294                        |       | 17,460                      |       |
| Accounts receivable                                                                                            |       | 726                          |       | 549                         |       |
| Prepaid expenses and other current assets                                                                      |       | 1,752                        |       | 1,583                       |       |
| Current assets of discontinued operations                                                                      |       | 5,801                        |       | 8,445                       |       |
| Total current assets                                                                                           |       | 18,873                       |       | 28,741                      |       |
|                                                                                                           |       |                         |       |                        |       |
| Property and equipment, net                                                                                    |       | 306                          |       | 2,020                       |       |
| Restricted cash                                                                                                |       | 130                          |       | 280                         |       |
| Other assets                                                                                                   |       | 540                          |       | 1,404                       |       |
| Long-term assets of discontinued operations                                                                    |       | 8,696                        |       | 4,596                       |       |
| Total assets                                                                                                   |       | $                            | 28,545     |                        | $          | 37,041 |   |
|                                                                                                           |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ (DEFICIT)  EQUITY**                                                       |       |                         |       |                        |       |
| Current liabilities:                                                                                           |       |                         |       |                        |       |
| Accounts payable and accrued expenses                                                                          |       | $                            | 12,883     |                        | $          | 11,535 |   |
| Notes payable, current portion                                                                                 |       | 13,630                       |       | 6,521                       |       |
| Capital lease obligations, current portion                                                                     |       | 6                            |       | 886                         |       |
| Current liabilities of discontinued  operations                                                                |       | 6,808                        |       | 2,552                       |       |
| Total current liabilities                                                                                      |       | 33,327                       |       | 21,494                      |       |
|                                                                                                           |       |                         |       |                        |       |
| Note payable, net of current portion                                                                           |       | 2,500                        |       | 1,200                       |       |
| Other long-term liabilities                                                                                    |       | 39                           |       | 11                          |       |
| Long-term liabilities of discontinued  operations                                                              |       | 873                          |       | —                      |       |
| Total liabilities                                                                                              |       | 36,739                       |       | 22,705                      |       |
|                                                                                                           |       |                         |       |                        |       |
| Stockholders’ (deficit) equity:                                                                           |       |                         |       |                        |       |
| Common stock, $.001 par value, 90,000  shares authorized 31,808 and 31,648 shares outstanding in 2008 and 2007 |       | 32                           |       | 32                          |       |
| Additional paid-in-capital                                                                                     |       | 258,914                      |       | 255,728                     |       |
| Accumulated deficit                                                                                            |       | (267,140                     | )          | (241,424                    | )          |
| Total stockholders’ (deficit) equity                                                                      |       | (8,194                       | )          | 14,336                      |       |
| Total liabilities and stockholders’  (deficit) equity                                                     |       | $                            | 28,545     |                        | $          | 37,041 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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**OSIRIS THERAPEUTICS, INC.**

**Condensed Statements of Operations**

**Unaudited**

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

 
| ** **                                                                              | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Revenue from government contracts,  collaborative research agreements and royalties** |       | $                                                        | 995        |                                                    | $          | 294 |   | $ | 3,887 |   | $ | 868 |   |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Operating expenses:**                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Research and development                                                                |       | 18,592                                                   |       | 10,842                                                  |       | 54,334 |   | 29,776 |   |
| General and administrative                                                              |       | 1,887                                                    |       | 1,294                                                   |       | 6,277 |   | 4,301 |   |
|                                                                                    |       | 20,479                                                   |       | 12,136                                                  |       | 60,611 |   | 34,077 |   |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Loss from operations**                                                                |       | (19,484                                                  | )          | (11,842                                                 | )          | (56,724 | ) | (33,209 | ) |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Interest expense, net**                                                               |       | (419                                                     | )          | (330                                                    | )          | (800 | ) | (1,091 | ) |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Loss from continuing operations**                                                     |       | (19,903                                                  | )          | (12,172                                                 | )          | (57,524 | ) | (34,300 | ) |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Discontinued operations:**                                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Income (loss) from operations of  discontinued operations                               |       | (384                                                     | )          | 1,782                                                   |       | 6,269 |   | 1,951 |   |
| Gain from sale of discontinued operations                                               |       | 25,539                                                   |       | —                                                  |       | 25,539 |   | — |   |
| **Income from discontinued operations**                                                 |       | 25,155                                                   |       | 1,782                                                   |       | 31,808 |   | 1,951 |   |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Net income (loss)**                                                                   |       | $                                                        | 5,252      |                                                    | $          | (10,390 | ) | $ | (25,716 | ) | $ | (32,349 | ) |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| **Basic and diluted net income (loss) per  share:**                                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Loss from continuing operations                                                         |       | $                                                        | (0.63      | )                                                       | $          | (0.42 | ) | $ | (1.81 | ) | $ | (1.22 | ) |
| Income from discontinued operations                                                     |       | 0.80                                                     |       | 0.06                                                    |       | 1.00 |   | 0.07 |   |
| Net income (loss)                                                                       |       | $                                                        | 0.17       |                                                    | $          | (0.36 | ) | $ | (0.81 | ) | $ | (1.15 | ) |
|                                                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted Average Common Shares (basic and  diluted)                                     |       | 31,808                                                   |       | 29,230                                                  |       | 31,799 |   | 28,234 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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**OSIRIS THERAPEUTICS, INC.**

**Condensed Statement of Stockholders’ (Deficit) Equity**

**For the nine months ended September 30, 2008**

**Unaudited**

**Amounts in thousands, except for share and per share data**

 
| ** **                                                                      | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **             | ** ** | **Total**                 | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                      | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                      | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**            | ** ** | **(Deficit) Equity** | ** ** |
| **Balance at January 1, 2008**                                             |       | 31,648,437            |       | $           | 32         |            | $          | 255,728                |       | $                         | (241,424   | ) | $ | 14,336 |   |
|                                                                            |       |                  |       |        |       |            |       |                   |       |                      |       |
| Induced conversion of convertible notes  into common stock ($14.00 per share)   |       | 87,524                |       | —      |       | 1,500           |       | —                 |       | 1,500                     |       |
|                                                                            |       |                  |       |        |       |            |       |                   |       |                      |       |
| Exercise of options to purchase common  stock ($0.40 - $6.84 per share)    |       | 50,569                |       | —      |       | 262             |       | —                 |       | 262                       |       |
|                                                                            |       |                  |       |        |       |            |       |                   |       |                      |       |
| Issuance of common stock for services  rendered by directors ($12.01 per share) |       | 21,500                |       | —      |       | 258             |       | —                 |       | 258                       |       |
|                                                                            |       |                  |       |        |       |            |       |                   |       |                      |       |
| Share-based payment — employee compensation                                |       | —                |       | —      |       | 1,166           |       | —                 |       | 1,166                     |       |
|                                                                            |       |                  |       |        |       |            |       |                   |       |                      |       |
| Net loss for the period                                                         |       | —                |       | —      |       | —          |       | (25,716                | )          | (25,716                   | )          |
|                                                                            |       |                  |       |        |       |            |       |                   |       |                      |       |
| **Balance at September  30, 2008**                                    |       | 31,808,030            |       | $           | 32         |            | $          | 258,914                |       | $                         | (267,140   | ) | $ | (8,194 | ) |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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 **OSIRIS THERAPEUTICS, INC.**

**Condensed Statements of Cash Flows**

**Unaudited**

**Amounts in thousands**

 
| ** **                                                                                               | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
|                                                                                                     |       |                                                    |       |   |   |
| **Cash flows from operating activities:**                                                                |       |                                                    |       |   |   |
| **Continuing Operations:**                                                                               |       |                                                    |       |   |   |
| Loss from continuing operations                                                                          |       | $                                                       | (57,524    | ) | $ | (34,300 | ) |
| **Adjustments to reconcile loss from  continuing operations to net cash used in continuing operations:** |       |                                                    |       |   |   |
| Depreciation and amortization                                                                            |       | 1,453                                                   |       | 1,261 |   |
| Non cash share-based payments                                                                            |       | 1,290                                                   |       | 1,164 |   |
| Non cash interest expense                                                                                |       | 130                                                     |       | 182 |   |
| **Changes in operating assets and  liabilities:**                                                        |       |                                                    |       |   |   |
| Accounts receivable                                                                                      |       | (177                                                    | )          | 73 |   |
| Prepaid expenses and other current assets                                                                |       | (169                                                    | )          | (40 | ) |
| Other assets                                                                                             |       | 864                                                     |       | 393 |   |
| Accounts payable and accrued expenses                                                                    |       | (2,950                                                  | )          | (1,389 | ) |
| Deferred revenue                                                                                         |       | —                                                  |       | (714 | ) |
| Long-term interest payable and other  liabilities                                                        |       | (839                                                    | )          | 299 |   |
| Net cash used in continuing operations                                                                   |       | (57,922                                                 | )          | (33,071 | ) |
| **Discontinued Operations:**                                                                             |       |                                                    |       |   |   |
| Income from discontinued operations                                                                      |       | 31,808                                                  |       | 1,951 |   |
| **Adjustments to reconcile income to net cash  provided by discontinued operations:**                    |       |                                                    |       |   |   |
| Gain from sale of discontinued operations,  net of non-cash charges                                      |       | (27,986                                                 | )          | — |   |
| Depreciation and amortization                                                                            |       | 295                                                     |       | 80 |   |
| Provision for bad debts                                                                                  |       | 29                                                      |       | — |   |
| Non cash share-based payments                                                                            |       | 134                                                     |       | 66 |   |
| **Changes in operating assets and  liabilities:**                                                        |       |                                                    |       |   |   |
| Accounts receivable                                                                                      |       | 844                                                     |       | (236 | ) |
| Inventory and other current assets                                                                       |       | 1,066                                                   |       | (546 | ) |
| Accounts payable and accrued expenses                                                                    |       | 4,256                                                   |       | 23 |   |
| Long-term liabilities                                                                                    |       | 873                                                     |       | — |   |
| Net cash provided by discontinued  operations                                                            |       | 11,319                                                  |       | 1,338 |   |
| Net cash used in operating activities                                                                    |       | (46,603                                                 | )          | (31,733 | ) |
|                                                                                                     |       |                                                    |       |   |   |
| **Cash flows from investing activities:**                                                                |       |                                                    |       |   |   |
| Purchases of property and equipment                                                                      |       | (4,029                                                  | )          | (4,184 | ) |
| Proceeds from the sale of property and  equipment                                                        |       | 104                                                     |       | — |   |
| Proceeds from sale of discontinued  operations, net of transaction costs                                 |       | 33,636                                                  |       | — |   |
| Proceeds from sale of investments available  for sale                                                    |       | 12,353                                                  |       | 35,787 |   |
| Purchases of investments available for sale                                                              |       | —                                                  |       | (18,730 | ) |
| Net cash provided by investing activities                                                                |       | 42,064                                                  |       | 12,873 |   |
|                                                                                                     |       |                                                    |       |   |   |
| **Cash flows from financing activities:**                                                                |       |                                                    |       |   |   |
| Principal payments on capital lease  obligations and notes payable                                       |       | (8,277                                                  | )          | (896 | ) |
| Restricted cash                                                                                          |       | 150                                                     |       | 17 |   |
| Proceeds from convertible and short-term  notes payable                                                  |       | 17,000                                                  |       | — |   |
| Proceeds from issuance of common stock                                                                   |       | 262                                                     |       | 20,009 |   |
| Payment of debt financing fees                                                                           |       | —                                                  |       | (400 | ) |
| Net cash provided by financing activities                                                                |       | 9,135                                                   |       | 18,730 |   |
|                                                                                                     |       |                                                    |       |   |   |
| Net increase (decrease) in cash                                                                          |       | 4,596                                                   |       | (130 | ) |
| Cash at beginning of period                                                                              |       | 704                                                     |       | 714 |   |
|                                                                                                     |       |                                                    |       |   |   |
| **Cash at end of period:**                                                                               |       | $                                                       | 5,300      |   | $ | 584 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTESTO UNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

**1.****                                                                                     ****Basis of Presentation**

 

The accompanying unaudited condensed financialstatements of Osiris Therapeutics, Inc. (the “Company”) have been preparedin accordance with generally accepted accounting principles in the UnitedStates and the rules and regulations of the United States Securities andExchange Commission (the “SEC”), for interim financial information. Accordingly, they do not include all the information and footnotes required bygenerally accepted accounting principles for complete financial statements andshould be read in conjunction with the Company’s Annual Report on Form 10-Kfor the fiscal year ended December 31, 2007.  The interim financialstatements are unaudited, but in the opinion of management all adjustments,consisting only of normal recurring accruals, considered necessary for a fairstatement of the results of these interim periods have been included.  Theinterim financial statements for the three and nine months ended September 30,2007 and the balance sheet as of December 31, 2007 have been reclassifiedto report our Osteocel business unit as discontinued operations, as discussedin Note 4 to these condensed financial statements.  The results of theCompany’s operations for any interim period are not necessarily indicative ofthe results that may be expected for any other interim period or for a fullfiscal year.

 

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

 

***Use of Estimates***

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes.  Due to the inherentuncertainty involved in making those assumptions, actual results could differfrom those estimates.  We believe that the most significant estimates thataffect our financial statements are those that relate to inventory valuation,deferred tax assets, and share-based compensation.

 

***Revenue Recognition***

 

Our revenue recognition policies are in accordancewith SEC Staff Accounting Bulletin No. 101, *Revenue Recognition in Financial Statements*, as amended bySEC Staff Accounting Bulletin No. 104, *RevenueRecognition*.

 

In October 2008, we entered into a CollaborationAgreement with Genzyme Corp. (“Genzyme”) for the development andcommercialization of Prochymal® and Chondrogen®, as further discussed in Note 3to these condensed financial statements. Under this agreement, Genzyme is obligated to pay to us non-contingent,non-refundable cash payment of $130.0 million, with $75.0 million to be paidduring November 2008 and $55.0 million to be paid on July 1, 2009.

 

This Collaboration Agreement has multipledeliverables, and we are currently evaluating the accounting for the noncontingent, non refundable cash payment and the other elements of theagreement.

 

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 from the United States Department of Defense (“DoD”)pursuant to which we, in partnership with Genzyme, are seeking to develop andstockpile Prochymal for the repair of gastrointestinal injury resulting fromacute radiation exposure.  We began recognizing revenue under thiscontract during the first quarter of 2008.  Contract revenue is recognizedas the related costs are incurred, in accordance with the terms of thecontract.  During the nine months ended September 30, 2008, werecognized $1.7 million in revenue from the DoD contract.

 

In October 2007, we entered into a collaborativeagreement with the Juvenile Diabetes Research Foundation (“JDRF”) to conduct aPhase II clinical trial evaluating Prochymal as a treatment for type 1 diabetesmellitus.  This collaborative agreement provides for JDRF to provide up to$4.0 million in funding to support the development of Prochymal for thepreservation of insulin production in patients with newly diagnosed type 1diabetes mellitus.  During the nine months ended September 30, 2008,we recognized $2.0 million in revenue upon the achievement of certainmilestones delineated in our agreement with JDRF.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

***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 conversion of convertible debt andoutstanding stock options and warrants are excluded from the computation ofdiluted loss per share as their effect is anti-dilutive.

 

***InvestmentsAvailable for Sale***

 

Investments available for sale consist primarily ofinvestment grade student loan auction rate certificates.  Thesecertificates are valued at estimated fair value, which approximates their parvalue at September 30, 2008.

 

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 nearterm recovery of value are not necessarily favorable, or that there is a lackof evidence to support fair values equal to, or greater than, the carryingvalue of the security.  Management reviews criteria such as the magnitudeand duration of the decline, as well as the reasons for the decline, to predictwhether the loss in value is other thantemporary.  Once a decline in value is determined to be other thantemporary, the value of the security is reduced and a corresponding charge toearnings is recognized. Our investments available for sale at September 30,2008 consist of investment grade student loan auction rate certificates thatare scheduled to be redeemed at par value within the next two to four months,pursuant to agreements by and between the investment banks and the SEC.

 

***Stock-BasedCompensation Plans***

 

In 1994, we adopted the Amended and Restated 1994Stock Incentive Plan (the “1994 Plan”) under which 875,000 shares of commonstock have been reserved for issuance upon the exercise of options or otherequity grants that we issue from time to time.  In 2006, we adopted the2006 Omnibus Plan, under which we initially reserved 850,000 shares ofcommon stock for issuance upon the exercise of stock options or other equitygrants.  At our Annual Meeting of Stockholders held on June 4, 2008,our stockholders approved our Amended and Restated 2006 Omnibus Plan, pursuantto which our 2006 Omnibus Plan was amended and restated to, among other things,increase the number of shares available for grant at any time thereunder by600,000 shares from 850,000 to 1,450,000.  We stopped granting optionsunder the 1994 Plan upon the completion of our initial public offering in August 2006.

 

A summary of the combined activity under both of ourstock-based compensation plans as of September 30, 2008 and changes duringthe nine 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, 2007  |       | 880,410                    |       | $                                                                                           | 8.64       |                                                            | 7.2        |                                        | $          | 5,091 |   |
| Granted                                |       | 467,000                    |       | 12.94                                                                                       |       |                                                            |       |                                        |       |
| Exercised                              |       | (50,569                    | )          | 5.18                                                                                        |       |                                                            |       | 402                                         |       |
| Forfeited or expired                   |       | (91,875                    | )          | 12.34                                                                                       |       |                                                            |       |                                        |       |
| Outstanding at September 30, 2008 |       | 1,204,966                  |       | 10.16                                                                                       |       | 8.0                                                             |       | 11,448                                      |       |
|                                   |       |                       |       |                                                                                        |       |                                                            |       |                                        |       |
| Exercisable at September 30, 2008 |       | 417,263                    |       | 4.10                                                                                        |       | 6.5                                                             |       | 6,484                                       |       |
|                                        |            |                            |            |                                                                                             |            |                                                                 |            |                                             |            |  |  |

 

The weighted average grant date fair value of optionsgranted during the nine months ended September 30, 2008 was $8.42 pershare.  We received a total of $262 in cash from the exercise of options duringthe nine months ended September 30, 2008.

 

Also during the nine months ended September 30,2008, we granted 21,500 unrestricted shares of common stock to members of ourBoard of Directors under our 2006 Omnibus Plan and recognized $258 inshare-based expense.  As of September 30, 2008, 590,260 shares ofcommon stock remain available for future grants under our Amended and Restated2006 Omnibus Plan.

 

Share-based compensation expense (including directorcompensation) included in our statements of operations for the three and ninemonths ended September 30, 2008 and 2007 is allocable to our biologic drugcandidate business, discontinued operations and general and administrativeactivities, as follows:

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Biologic drug candidates   |       | $                                                        | 192        |                                                    | $          | 252 |   | $ | 522 |   | $ | 582 |   |
| Discontinued operations    |       | 55                                                       |       | 15                                                      |       | 134 |   | 37 |   |
| General and administrative |       | 213                                                      |       | 114                                                     |       | 768 |   | 611 |   |
| Total                      |       | $                                                        | 460        |                                                    | $          | 381 |   | $ | 1,424 |   | $ | 1,230 |   |

 

As of September 30, 2008, there was approximately$5.8 million of total unrecognized share-based compensation cost related tooptions granted under our plans which will be recognized over aweighted-average period of approximately 3.5 years.

 

***Supplemental CashFlow Information***

 

| ** **                                                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Supplemental disclosure of cash flows  information:**                    |       |                                                |       |   |   |
| Cash paid for interest                                                     |       | $                                                   | 577        |   | $ | 1,219 |   |
| Cash paid for income taxes                                                 |       | —                                              |       | — |   |
|                                                                       |       |                                                |       |   |   |
| **Supplemental schedule of non-cash investing and  financing activities:** |       |                                                |       |   |   |
| Common stock issued to directors for services rendered                     |       | 258                                                 |       | 295 |   |
|                                                                            |            |                                                     |            |  |  |  |  |

 

***Significant NewAccounting Pronouncements***

 

On December 12, 2007, the Financial AccountingStandards Board, or FASB, ratified the consensus reached by the Emerging IssuesTask Force, or EITF, on EITF Issue No. 07-1, *“Accounting for Collaborative Arrangements,”* or EITF07-1.  EITF 07-1 defines collaborative arrangements and establishesreporting requirements for transactions between participants in a collaborativearrangement and between participants in the arrangement and thirdparties.  EITF 07-1 is effective for financial statements issued forfiscal years beginning after December 15, 2008.  We do not believethe impact of adopting EITF 07-1 will have a material impact on ourfinancial statements.

 

On June 27, 2007, the FASB ratified the consensusreached by the EITF on EITF Issue No. 07-3,*“Accounting for Nonrefundable Advance Payments forGoods or Services to Be Used in Future Research and Development Activities,”*or EITF 07-3.  EITF 07-3 requires companies to defer andcapitalize prepaid, nonrefundable research and development payments to thirdparties, and amortize them over the period that the research and developmentactivities are performed or the services are provided, subject to an assessmentof recoverability.  EITF 07-3 is effective for new contracts enteredinto during fiscal years beginning after December 15, 2007, includinginterim periods within those fiscal years.  We adopted EITF 07-3 in thefirst quarter of 2008.  There was no material impact on our financialstatements upon adoption.

 

In September 2006, the FASB issued Statement ofFinancial Accounting Standards, or SFAS, No. 157, *“Fair Value Measurements.”* This standarddefines fair value, establishes a framework for measuring fair value undergenerally accepted accounting principles, and expands disclosures about fairvalue measurements.  SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007,except that under FASB Staff Position 157-2, *“EffectiveDate of FASB Statement No. 157,”* companies are allowed to delaythe effective date of SFAS No. 157 for non-financial assets andnon-financial liabilities that are not recognized or disclosed at fair value ona recurring basis until fiscal years beginning after November 15,2008.  We adopted SFAS No. 157 with regard to all financialassets and liabilities in our financial statements in the first quarter of 2008and have elected to delay the adoption of SFAS No. 157 for non-financialassets and non-financial liabilities not recognized or disclosed at fair valueon a recurring basis until the first quarter of 2009.  For furtherdiscussion of SFAS No. 157, see Note 6 to the Condensed FinancialStatements.

 

In February 2007, the FASB issued SFAS No. 159,*“The Fair Value Option for Financial Assetsand Financial Liabilities—including an amendment of FASB Statement No. 115.”*  SFAS No. 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value.  Entitiesthat elect the fair value option will report unrealized gains and losses inearnings at each subsequent reporting date. The fair value option may beelected on an instrument-by-instrument basis, with few exceptions. SFAS No. 159 also establishes presentation and disclosurerequirements to facilitate comparisons between companies that choose differentmeasurement attributes for similar assets and liabilities.  SFAS No. 159is effective for fiscal years beginning after November 15, 2007. Weadopted SFAS No. 159 in the first quarter of 2008.There was no materialimpact on our financial statements upon adoption.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

In March 2008, the FASB issued SFAS No. 161,*“Disclosures about Derivative Instrumentsand Hedging Activities—an amendment of FASB Statement No. 133.*” SFAS No. 161 will require entities to provide qualitative disclosuresabout the objectives and strategies for using derivatives, quantitativedisclosures about the fair value of gains and losses on derivative contracts,and disclosures about credit-risk related to contingent features in theirhedged positions.  The statement also asks entities to disclose moreinformation about (i) the location and amounts of derivative instrumentsin financial statements; (ii) how derivatives and related hedges areaccounted for under SFAS No. 133; and (iii) how the hedges affect theentity’s financial position, financial performance and cash flows.  Thestatement is effective for fiscal years and interim periods beginning after November 15,2008, with early application encouraged, but not required.  As of September 30,2008 we have not adopted SFAS No. 161.  We do not expect the adoptionof SFAS No. 161 to have a material impact on our financial statements.

 

In May 2008, theFASB issued SFAS No. 162, “*The Hierarchy of GenerallyAccepted Accounting Principles*”. SFAS No. 162 identifies thesources of accounting principles and the framework for selecting the principlesused in the preparation of financial statements. SFAS No. 162 is effective60 days following the SEC’s approval of the Public Company Accounting OversightBoard amendments to AU Section 411, “*The Meaning of PresentFairly in Conformity with Generally Accepted Accounting Principles*”.The implementation of this standard will not have a material impact on ourfinancial statements.

 

In May 2008, theFASB issued FASB Staff Position No. APB 14-1 (“FSP”). The FSP specifiesthat issuers of convertible debt instruments that permit or require the issuerto pay cash upon conversion should separately account for the liability andequity components in a manner that will reflect the entity’s nonconvertibledebt borrowing rate when interest cost is recognized in subsequent periods. TheFSP is effective for financial statements issued for fiscal years beginningafter December 15, 2008, and interim periods within those fiscal years.This FSP is applicable to our $10.5 million of convertible notes.  Weare currently assessing the impact the adoption of FSP APB 14-1 will have onour financial statements.

 

** 3.****                                  ****Subsequent Event –Collaboration Agreement with Genzyme Corp.**

 

On October 31, 2008,we entered into a Collaboration Agreement with Genzyme for the development andcommercialization of Prochymal and 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 Graft vs. Host Disease (“GvHD”) in Japan where Prochymalhas previously been licensed to another pharmaceutical company.

 

As partial considerationfor the grant of these rights, we will receive a non-contingent, non-refundablepayment of $130.0 million cash from Genzyme, with $75.0 million paid in November 2008and $55.0 million to be paid on July 1, 2009.  We are currently evaluating the accountingfor the multiple elements of this agreement. The Collaboration Agreement also provides for contingent milestonepayments of up to $1.25 billion in the aggregate, in addition to royalties onany sales by Genzyme, to be paid by Genzyme to us, as follows:

 

*Prochymal*:   As respects to Prochymal, we areeligible to receive up to $500.0 million in development and regulatorymilestone payments and up to $250.0 million in sales based milestone payments,as follows:

 

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

 

·                                                                                          Total development milestones of up to$180.0 million related to Crohn’s disease and Ulcerative Colitis, with $50.0million payable upon achieving statistically significant endpoint(s) in aPhase III clinical trial for Crohn’s disease, $100.0 million payable uponmarketing approval by the EMEA for Crohn’s disease, $10.0 million payable uponachieving statistically significant endpoint(s) in a Phase II or Phase IIIclinical trial for 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 II clinicaltrial for acute myocardial infarction, type 1 diabetes or other follow-onindications, as agreed to by the Company and Genzyme, and $40.0 million payableupon receipt of each marketing approval by the EMEA for Prochymal for chronicobstructive pulmonary disease (“COPD”), acute myocardial infarction, type 1diabetes mellitus or other follow-on indications, as agreed to by the Companyand Genzyme.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

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

 

*Chondrogen*:   Upon receipt of the results ofthe planned Phase II/III clinical trial of Chondrogen, Genzyme may elect toopt-out of further Chondrogen development, at which point all rights toChondrogen will revert to us with no further obligations between the companieswith regard to Chondrogen.  If Genzyme does not opt-out, we are eligibleto receive up to $500.0 million in development, regulatory and sales basedmilestone payments for Chondrogen, as follows:

 

·                                                                                          Total development and regulatorymilestones of up to $100.0 million, with $10.0 million payable if Genzyme doesnot opt-out, $10.0 million payable upon demonstration of disease modificationin the current clinical trial program, $40.0 million payable upon marketingapproval by either the FDA or EMEA for a pain reduction indication, and $40.0million payable upon marketing approval by either the FDA or EMEA for a diseasemodification indication.

 

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

 

**Development Costs:**   The Collaboration Agreement alsoprovides that we will be solely responsible for ongoing clinical trial costsand future clinical trial costs with respect to both Prochymal and Chondrogenthrough Phase II clinical trials.  We and Genzyme will share all costs offuture Phase III and Phase IV clinical trials for agreed-upon indications(assuming in the case of Chondrogen that Genzyme does not opt-out), with usbeing responsible for 60% of such costs and Genzyme responsible for 40% of suchcosts.

 

**Product Royalties:**   Assuming successful developmentand marketing approval, we will receive escalating royalties on sales ofProchymal and Chondrogen within the Genzyme Territory.

 

**U.S. & Canada Launch Support:**   Genzymewill provide launch support starting six months prior to the commercializationof Prochymal in the United States and Canada, including pharmaco-economicanalysis, product reimbursement, deploying a sales force, the development andimplementation of brand positioning and customer support, among other services.Genzyme will provide such services for two-years from the first commercial salein the United States and Canada and be compensated for such services throughthe payment of royalties on the net sales of Prochymal made in the UnitedStates and Canada during this time period.

 

**Term:**   The Collaboration Agreement provides that itwill expire upon the completion of all development plans stipulated in theCollaboration Agreement and the expiration of all payment obligations; however,Genzyme may terminate the Agreement early and without further obligation at anytime after July 1, 2009, and either party may terminate the CollaborationAgreement due to non-performance, material breach or insolvency.

 

**4.****                                                                                     ****Discontinued Operations**

 

In April 2008, we committed to a plan to sell ourbiologic tissue product business, including our entire product line relating tothe processing, manufacturing, marketing and selling of Osteocel® and OsteocelXO®, an allograft material containing cancellous bone, used in spinal fusionand other surgical procedures.  We refer to these assets as our Osteocelasset disposal group.  Not included among the Osteocel asset disposalgroup is Osteocel® XC, our second generation product candidate underdevelopment for bone repair, utilizing culture expanded mesenchymal stem cellsto create a synthetic version of Osteocel.  On May 8, 2008, weentered into an Asset Purchase Agreement to sell the Osteocel asset disposalgroup to NuVasive, Inc., a Delaware corporation.  The agreementprovides for the sale to be effected at two closings —a technology assetsclosing, at which technology and certain other business assets are transferred,and a manufacturing assets closing, at which manufacturing assets andfacilities are transferred.  On July 24, 2008, we held a SpecialMeeting of Stockholders at which our stockholders overwhelmingly approved thesale of the Osteocel business.  The technology assets closing alsooccurred on that date, at which time we received an initial payment of $35.0million.  The manufacturing assets closing is expected to occurapproximately 18 months after the date of the technology assets closing.  Concurrent with the technology assetsclosing, we entered into a Manufacturing Agreement with NuVasive, under whichwe will continue to manufacture Osteocel for up to 18-months and sell 100% ofthe product to NuVasive at specified prices.  NuVasive has certain minimumpurchase order obligations under the Manufacturing Agreement.  We couldrecognize up to approximately $40.0 million in revenue from discontinuedoperations under the Manufacturing Agreement, but do not expect to reportsignificant profits, if any, from manufacturing the product under thisManufacturing Agreement.

 

In September 2008, we entered into amendments tothe Asset Purchase Agreement and the related Manufacturing Agreement toaccommodate reduced shipments of Osteocel by NuVasive to Blackstone Medical, Inc.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

The Asset Purchase Agreement, as amended, provides forup to $50.0 million of contingent additional payments to us upon ourachievement of milestone events; in addition to the $35.0 million initialpayment, as follows:

 
| ** **                                      | ** ** | ** ** | ** ** | **Cut-Off**       | ** **                   |
|-------------------------------------------------|------------|------------|------------|-------------------|------------------------------|
| **Milestone**                                   | ** ** | **Amount** | ** ** | **Date**          | ** **                   |
| Initial payment                                 |       | $          | 35,000     |              | Received  in  July 2008 |   |
|                                            |       |       |       |              |                         |
| Cumulative sales to NuVasive of 75,000 units(1) |       | 5,000      |       | April 2009   |                         |
| Cumulative sales to NuVasive of 180,000 units   |       | 5,000      |       | January 2010 |                         |
| Net end-user sales of $35 million               |       | 15,000     |       | none              |                         |
| Cumulative sales to NuVasive of 205,000 units   |       | 5,000      |       | January 2010 |                         |
| Cumulative sales to NuVasive of 308,300 units   |       | 2,500      |       | January 2010 |                         |
| Cumulative sales to NuVasive of 350,000 units   |       | 2,500      |       | January 2010 |                         |
| Cumulative sales to NuVasive of 350,000 units   |       | 2,500      |       | January 2010 |                         |
| Transfer of Manufacturing Assets                |       | 12,500     |       | January 2010 |                         |
|                                            |       |       |       |              |                         |
| Total possible purchase price                   |       | $          | 85,000     |              |                         |   |

 

----

(1) Each unitrepresents 1.0 cubic centimeter of Osteocel product.

 

If and when the requisite milestone events occur, wewill recognize the milestone proceeds as a component of gain (loss) from thesale of discontinued operations.

 

We recognized a gain on the technology assets closingof $25,539 in the third quarter of 2008. We incurred transaction costs of$1,364, including legal, accounting and advisory fees.  We also established reserves totaling $8,097to recognize the concessionary pricing of Osteocel that we will produce underthe Manufacturing Agreement as amended. These reserves will be amortized into the income (loss) from operationsof discontinued operations through the end of 2009, concurrent with ourfulfillment of our obligations under the Manufacturing Agreement.  At September 30, 2008, $4,298 of thesereserves are included in current liabilities of discontinued operations and$873 are recorded as long-term liabilities of discontinued operations.

 

The net assets allocable to the Osteocel assetdisposal group at September 30, 2008 and December 31, 2007 were asfollows:

 
| ** **                                | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| Accounts receivable                       |       | $        | 3,337      |     | $          | 4,324 |   |
| Inventory                                 |       | 2,346    |       | 3,983    |       |
| Other current assets                      |       | 118      |       | 138      |       |
|                                      |       |     |       |     |       |
| Current assets of discontinued operations |       | 5,801    |       | 8,445    |       |
|                                      |       |     |       |     |       |
| Property and equipment, net               |       | 8,696    |       | 4,596    |       |
|                                      |       |     |       |     |       |
| Liabilities of discontinued operations    |       | (7,681   | )          | (2,552   | )          |
|                                      |       |     |       |     |       |
| Net assets of discontinued operations     |       | $        | 6,816      |     | $          | 10,489 |   |

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

We eliminated the Osteocel asset disposal group fromour ongoing operations as a result of the disposal transaction and have presentedthe results of the group’s operations as a discontinued operation for allperiods.  Summarized operating results of the Osteocel asset disposalgroup are as follows:

 
| ** **                                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Product sales                                            |       | $                                                    | 2,872      |                                                | $          | 4,003 |   | $ | 19,338 |   | $ | 9,255 |   |
| Cost of goods sold                                       |       | 3,035                                                |       | 1,826                                               |       | 11,602 |   | 4,230 |   |
| Gross profit (loss)                                      |       | (163                                                 | )          | 2,177                                               |       | 7,736 |   | 5,025 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Failed production runs                                   |       | —                                               |       | 246                                                 |       | — |   | 2,679 |   |
| Selling, general & administrative expenses      |       | 221                                                  |       | 149                                                 |       | 1,467 |   | 395 |   |
|                                                     |       | 221                                                  |       | 395                                                 |       | 1,467 |   | 3,074 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss) from operations of discontinued operations |       | $                                                    | (384       | )                                                   | $          | 1,782 |   | $ | 6,269 |   | $ | 1,951 |   |

 

**5.****                                                                                     ****Notes Payable &Related Party Transactions**

 

In March and May 2008, we issued anaggregate of $10.5 million in convertible promissory notes to several non-U.S.investors pursuant to a private placement intended to qualify under RegulationS and Section 4(2) of the Securities Act of 1933, as amended. Threeof these notes with an aggregate principal amount of $8.0 million bear interestat 2% and become due and payable on November 30, 2008.  The fourthnote with a principal amount of $2.5 million bears interest at 4% andbecomes due and payable on November 30, 2009. The notes are convertible atthe option of the respective holders at any time, into shares of our commonstock at conversion prices ranging from $12.04 to $13.18 per share (therespective closing prices on the NASDAQ Global Market on the dates of the definitiveagreements). The notes provide for redemption at any time at our option, with30-days prior written notice.  The note holders are afforded certainregistration rights in respect of any shares issued upon conversion.

 

In June 2008, we issued an aggregate of $5.5million in short-term notes, and in July 2008, we issued an aggregate of $1.0million in short-term notes to several non-U.S. investors pursuant to a privateplacement intended to qualify under Regulation S and Section 4(2) ofthe Securities Act of 1933, as amended.  These notes bear interest at 10%semi-annually and become due and payable in December 2008.  The notesare not convertible but are redeemable at our option with ten days priorwritten notice, upon any monthly anniversary of the date of issuance. Inthe third quarter of 2008, we repaid $2.5 million of these notes together withaccrued interest and expect to retire the remaining $4.0 million prior toDecember 31, 2008.

 

As previously disclosed in Current Reports filed onForm 8-K, Peter Friedli, the Chairman of our Board of Directors and largestshareholder participated in both the convertible promissory notes and theshort-term notes private placements.  OurBoard of Directors, including all of our independent directors, but with Mr.Friedli abstaining, together with our Audit Committee, unanimously approved theoffering and sales of the convertible and short-term notes to Mr. Friedli. AtSeptember 30, 2008, Mr. Friedli is the holder of a $2.5 million convertiblepromissory note dated March 25, 2008. The convertible promissory note bearsinterest at 2%, payable upon maturity on November 30, 2008 and is convertibleat any time at the sole discretion of Mr. Friedli into shares of our commonstock at the conversion price of $12.17 per share.  Mr. Friedli is also the holder of $4.0million in aggregate of our short-term notes which bear interest at 10%semi-annually and mature in December 2008.

 

Also, in December 2007, we issued a short-termpromissory note to a multinational pharmaceutical company in the principalamount of $6,521.  This note accrued interest at 8% and became due ininstallment payments during 2008.  We paid $4,890, plus accrued interest,during the nine months ended September 30, 2008.  This note was paid infull in the fourth quarter of 2008.

 

**6.**                                                                                      **Fair Value**

 

In September 2006, the FASB issued Statement No. 157,“*Fair Value Measurements,”* orSFAS No. 157.  SFAS No. 157 establishes a standard framework formeasuring fair value in generally accepted accounting principles, clarifies thedefinition of “fair value” within that framework, and expands disclosures aboutthe use of fair value measurements.  We adopted SFAS No. 157 inthe first quarter of 2008 with regard to all financial assets and liabilitiesin our financial statements going forward, and, consistent with FASB StaffPosition 157-2, *“Effective Date of FASBStatement No. 157,”* we have elected to delay the adoption ofSFAS No. 157 for non-financial assets and liabilities not recognized ordisclosed at fair value on a recurring basis until the first quarter of 2009.The adoption of SFAS No. 157 had no material impact on our financialstatements.

 

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**OSIRISTHERAPEUTICS, INC.**

**NOTES TOUNAUDITED CONDENSED FINANCIAL STATEMENTS**

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

 

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, fairvalue is based on observable market prices or parameters or derived from suchprices or parameters.  Where observable prices or inputs are notavailable, valuation models are applied.

 

Financial assets recorded at fair value in theCondensed Financial Statements are categorized based upon the level of judgmentassociated with the inputs used to measure their fair value.  Hierarchicallevels, defined by SFAS No. 157 and directly related to the amount ofsubjectivity associated with the inputs to fair valuation of these assets andliabilities, are as follows:

 

*Level 1* — Inputs are unadjusted, quoted pricesin active markets for identical assets at the reporting date.  Activemarkets are those in which transactions for the asset or liability occur insufficient frequency and volume to provide pricing information on an ongoingbasis.

 

The fair valued assets wehold that are generally included in this category are money market securitieswhere fair value is based on publicly quoted prices.

 

*Level 2* — Inputs are other than quoted pricesincluded in Level 1, which are either directly or indirectly observable for theasset or liability through correlation with market data at the reporting dateand for the duration of the instrument’s anticipated life.

 

The fair valued assets wehold that are generally included in this category are investment grade auctionrate certificates and commercial paper where fair value is based on valuationmethodologies such as models using observable market inputs, such as benchmarkyields, reported trades, broker/dealer quotes, bids, offers and other referencedata.

 

*Level 3* — Unobservable inputs that are supportedby little or no market activity and that are significant to the fair value ofthe assets or liabilities and which reflect management’s best estimate of whatmarket participants would use in pricing the asset or liability at thereporting date. Consideration is given to the risk inherent in the valuationtechnique 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:

 
| ** **                            | ** ** | **Fair value measurements at September 30, 2008 using** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | ** **                                                                                 | ** ** | **Quoted prices in  active markets for  identical assets** | ** ** | **Significant other  observable  inputs** | ** ** | **Significant  unobservable  inputs** | ** ** |
| ** **                            | ** ** | **September 30, 2008**                                                           | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Assets:                               |       |                                                                                       |       |   |   |   |   |   |   |
| Overnight securities included in Cash |       | $                                                                                          | 4,665      |   | $ | 4,665 |   | $ | — |   | $ | — |   |
| Investments available for sale        |       | 5,294                                                                                      |       | — |   | 5,294 |   | — |   |
|                                       |            |                                                                                            |            |  |  |  |  |  |  |  |  |  |  |

 

**7.****                                                                                     ****Commitments – ContractManufacturing Agreement**

 

In October 2008, we entered into a contractmanufacturing agreement with Lonza Walkersville, Inc. for the purchase ofProchymal for use in our clinical trials. This five-year agreement includes minimum purchase commitments throughDecember 31, 2009.  We expect to payLonza approximately $12.1 million during 2008, including purchases madethroughout the year, and approximately $15.2 million during 2009 under thisagreement and record such payments as a component of research and developmentexpenses.  

 

 

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

 

**Forward-Looking Information**

 

This 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-K underPart I—Item 1A, “Part II—Item 7.  Management’s Discussion andAnalysis 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 andprojected expenditures, including our anticipated timeline and clinicalstrategy for mesenchymal stem cells and biologic drug candidates(including theanticipated timeline and clinical strategy for Prochymal and Chondrogen); our cash needs; patents and proprietaryrights; ability of our potential products to treat disease; our plans for salesand marketing; our plans regarding facilities; types of regulatory frameworkswe expect will be applicable to our potential products; results of our scientificresearch; and our ability to benefit from the sale of our Osteocel business andto earn milestone payments and perform under and derive revenue from therelated manufacturing agreement, and our ability to benefit from ourcollaborations with Genzyme Corp. and to earn milestone payments and performunder and derive royalty and other revenue thereunder.  Risksand uncertainties related to our Collaboration Agreement with Genzyme for thedevelopment and commercialization of Prochymal and Chondrogen include, amongothers:  typical business transactional risks; risks related to productdevelopment and clinical trial design, performance and completion; uncertaintyof the success of Prochymal and Chondrogen in clinical trials and their abilityto treat disease; Genzyme’s early termination and opt-out rights; the abilityof Osiris and Genzyme to successfully navigate regulatory requirements and tomanufactureand commercialize products; and the uncertainty as to our ability tosuccessfully perform under the collaborative arrangement and earn milestone androyalty payments thereunder. All forward-looking statements, including, without limitation, management’sexamination of historical operating trends, are based upon our currentexpectations and various assumptions.  Our expectations, beliefs andprojections are expressed in good faith and we believe there is a reasonablebasis 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 thefollowing management’s discussion and analysis of our financial condition andresults of operations in conjunction with our audited Financial Statements andrelated notes thereto and other disclosures included as part of our AnnualReport on Form 10-K for the year ended December 31, 2007, and ourunaudited Condensed Financial Statements for the three and nine months ended September 30,2008 and other disclosures included in this Quarterly Report on Form 10-Q. Our Condensed Financial Statements have been prepared in accordance with U.S.generally accepted accounting principles and are presented in U.S. dollars.

 

There are a number of risksand uncertainties that could cause our actual results to differ materially fromthe forward-looking statements contained in this report. Some of the importantfactors that could cause our actual results to differ materially from theforward-looking statements we make in this report are set forth in our AnnualReport on Form 10-K for the fiscal year ended December 31, 2007 underPart I — Item 1A “Risk Factors,” and in our Quarterly Report on Form 10-Qfor the fiscal quarter ended March 31, 2008, and in this Quarterly Reporton Form 10-Q, under Part II – Item 1A “Risk Factors.”  There maybe other factors that may cause our actual results to differ materially fromthe forward-looking statements.

 

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

 

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

 

**Introduction and Overview**

 

The following is adiscussion and analysis of our financial condition and results of operationsfor the three and nine month periods ended September 30, 2008 and2007.  You should read this discussion together with the accompanyingunaudited condensed financial statements and notes and with our Annual Reporton Form 10-K for the year ended December 31, 2007.  Historicalresults and any discussion of prospective results may not indicate our futureperformance.  See “Forward Looking Information.”

 

We are a leading stem celltherapeutic company headquartered in Columbia, Maryland, focused on developingand marketing products to treat medical conditions in the inflammatory,orthopedic, and cardiovascular areas.  We were incorporated in Delaware inApril 2002.  Our predecessor company was organized in 1992.  Ourlead biologic drug candidate, Prochymal®, is being evaluated in Phase IIIclinical trials for three indications, including acute and steroid refractoryGvHD and Crohn’s disease, and is the only stem cell therapeutic currentlygranted both

 

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Orphan Drug and Fast Trackstatus by the Food and Drug Administration (“FDA”).  Prochymal is alsobeing developed for the repair of heart tissue following a heart attack, theprotection of pancreatic islet cells in patients with type 1 diabetesmellitus, and the treatment of patients with COPD.  Our pipeline ofinternally developed biologic drug candidates under evaluation also includesChondrogen for osteoarthritis in the knee.

 

As discussed more fully inNote 3 to the accompanying Condensed Financial Statements, on October 31,2008, subsequent to the close of our third fiscal quarter, we entered into aCollaboration Agreement with Genzyme for the global development andcommercialization of Prochymal and Chondrogen. Under the terms of the Collaboration Agreement, we retain the right tocommercialize Prochymal and Chondrogen in the United States and Canada andGenzyme is granted the exclusive right and license to commercialize theproducts in all other countries (except with respect to GvHD in Japan whereProchymal has previously been licensed to another pharmaceutical company). In July 2007we separately partnered with Genzyme for the development of effective countermeasuresto nuclear terrorism and other radiological emergencies.  In January 2008 we were awarded acontract from the U.S. Department of Defense, pursuant to which we, inpartnership with Genzyme, are seeking to develop and stockpile Prochymal forthe repair of gastrointestinal injury resulting from acute radiationexposure.   Additionally, we havepartnered with the JDRF for the development of Prochymal as a treatment for thepreservation of insulin production in patients with newly diagnosed type 1diabetes mellitus.

 

In April 2008, wecommitted to a plan to sell our assets related to Osteocel, a product that wehave produced and marketed since July 2005, for regenerating bone inorthopedic indications.  On May 8,2008 entered into an Asset Purchase Agreement to sell those assets, includingour entire product line relating to the processing, manufacturing, marketingand selling of Osteocel and Osteocel XO, to NuVasive, Inc.  The first of two scheduled closings inconnection with this transaction, the “technology assets closing”, occurred on July 24,2008, at which time we received an initial payment of $35.0 million.  Thesecond and final closing, the “manufacturing assets closing,” is expected tooccur approximately 18-months after the date of the technology assetsclosing.  Concurrent with the technologyassets closing, we entered into a Manufacturing Agreement with NuVasive, underwhich we will continue to manufacture Osteocel for up to 18-months and sell100% of the product to NuVasive at specified prices

 

We are a fully integratedcompany, having developed capabilities in research, development, manufacturing,marketing and distribution of stem cell products. We have developed anextensive intellectual property portfolio to protect our technology in the UnitedStates and a number of foreign countries, including 46 U.S. and 278 foreignpatents owned or licensed.  We believe that our biologic drug candidateshave advantages over other stem cell therapeutics in development for at leastthe following reasons:

 

·                                                                  **Stem Cell Source.**   Our stem cells are obtained fromadult bone marrow, a readily available source. The cells are drawn from thehips 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 (“MSC”) 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 therapies underdevelopment can elicit a rejection response in the recipient and thereforerequire donor-to-recipient matching or potentially harmful immunosuppression.This greatly reduces manufacturing efficiencies and creates a risk of mismatchwhich can result in an acute inflammatory response and, potentially, in death.Based on our clinical experience, we believe that our biologic drug candidatesare not rejected by the patient’s immune system and so, like type Onegative blood, do not require donor-to-recipient matching. This universalcompatibility allows us to produce a standardized product available to allpatients in almost any medical setting.

 

·                                                                  **Treatment on Demand.**   Our biologic drug candidates canbe 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 tablesummarizes key information about our biologic drug candidates.

 
| **Product/Candidate** | ** ** | **Indication**                                  | ** ** | **Status**                    |
|-----------------------|------------|-------------------------------------------------|------------|-------------------------------|
| **Prochymal**         |       | Steroid Refractory Acute GvHD    |       | Phase III                |
|                  |       | First Line Treatment of Acute GvHD              |       | Phase III                |
|                  |       | Biologics Refractory Crohn’s Disease       |       | Phase III                |
|                  |       | Type I Diabetes 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/III             |

 

**Financial Operations Overview**

 

*Revenue*

 

We recognize revenue oncollaborative and royalty agreements and a contract with the DoD for thedevelopment and stockpiling of Prochymal for the treatment of acute radiationsyndrome.  Our Collaboration Agreement with Genzyme for the developmentand commercialization of Prochymal and Chondrogen provides for up-front,non-contingent, non-refundable cash payment of $130.0 million, with $75.0million to be received during the fourth quarter of 2008 and $55.0 million on July 1,2009. This Collaboration Agreement also provides for contingent milestonepayments of up to $1.25 billion in the aggregate, in addition to royalties onany sales by Genzyme.  This CollaborationAgreement has multiple deliverables, and we are currently evaluating theaccounting for the non-contingent, non-refundable cash payment and the otherelements of the agreement.

 

Our collaborative agreementwith the JDRF provides for funding of up to $4.0 million in support ofdeveloping Prochymal as a treatment for the preservation of insulin productionin patients with newly diagnosed type 1 diabetes mellitus.  We recognizerevenue on this collaborative agreement when we achieve the specified milestoneevents.  During the nine months ended September 30, 2008, werecognized $2.0 million in revenue upon the achievement of certain milestonesunder this collaborative agreement.

 

*Research and Development Costs*

 

Our research and developmentcosts consist of expenses incurred in identifying, developing and testingbiologic drug candidates. These expenses consist primarily of salaries andrelated expenses for personnel, fees paid to professional service providers forindependent monitoring and analysis of our clinical trials, costs of contractresearch and manufacturing, costs of facilities, and the costs of manufacturingclinical batches of biologic drug candidates, quality control supplies andmaterial to expand biologic drug candidates.

 

Consistent with our focus onthe development of biologic drug candidates with potential uses in multipleindications, many of our costs are not attributable to a specificallyidentified project.  We use our employee and infrastructure resourcesacross several projects.  Accordingly, we do not account for internalresearch and development costs on a project-by-project basis.  As aresult, we cannot state precisely the total costs incurred for each of ourclinical and preclinical projects on a project-by-project basis.  Frominception in December 1992 through September 30, 2008, we incurredaggregate research and development costs of approximately $289.0 million.

 

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

 

·                                                               the design of the trial and trial endpoints;

 

·                                                               the number of patients who participate in thetrials;

 

·                                                               the number of sites included in the trials;

 

·                                                               the length of time required to enroll trialparticipants;

 

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·                                                               the duration of patient treatment andfollow-up;

 

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

 

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

 

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

 

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

 

Our Collaboration Agreementwith Genzyme also provides that we will be responsible, both financially andotherwise, for all ongoing clinical trial costs and for all future clinicaltrial costs with respect to both Prochymal and Chondrogen through Phase IIclinical trials.  We and Genzyme willshare all costs of future Phase III and IV clinical trials for agreed-uponindications, with Genzyme responsible for 40% of such costs and us responsiblefor 60% of such costs.

 

We have incurred annualoperating losses since inception and expect to incur substantial operatinglosses in the future in connection with the development of our core products. Asof September 30, 2008, we had an accumulated deficit of $267.1 million.

 

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*General and Administrative Expenses*

 

General and administrativeexpenses consist primarily of the costs associated with our general management,including salaries, allocations of facilities and related costs, andprofessional fees such as legal and accounting expenses. In anticipation of commercializationand bringing our biologic drug candidates to market, we are incurring increasesin our general and administrative expenses in the areas of business developmentand intellectual property.  We have also incurred increased general and administrativecosts for legal and accounting compliance costs, investor relations and otheractivities associated with operating as a publicly traded company. Continued increases will also likely result from the additional hiring ofoperational, financial, accounting, facilities engineering and informationsystems personnel.

 

*InterestExpense, Net*

 

Interest income consists ofinterest earned on our cash and short-term investments. Interest expenseconsists of interest incurred on convertible and short-term debt, capitalleases and other debt financings.  We pay interest on our short-termloans, capital leases and our convertible long-term debt.

 

*Income Taxes*

 

We have not recognized anydeferred tax assets or liabilities in our financial statements since we cannotassure their future realization. Because realization of deferred tax assets isdependent upon future earnings, a full valuation allowance has been recorded onthe net deferred tax assets, which relate primarily to net operating loss andresearch and development carry-forwards. In the event that we become profitablewithin the next several years, we have net deferred tax assets of approximately$80.0 million that may be utilized prior to us having to recognize any incometax expense or make payments to the taxing authorities.  Utilization ofour net operating loss carry-forwards in any one year may be limited underInternal Revenue Code Section 382, and we could be subject to the Federalalternative minimum tax.

 

**CriticalAccounting Policies**

 

There have been no materialchanges in our critical accounting policies, estimates and judgments during thenine months ended September 30, 2008 compared to the disclosures in Part II,Item 7 of our Annual Report on Form 10-K for the year ended December 31,2007, other than as disclosed herein.

 

**Results of Operations**

 

***Comparison of Three Months Ended September 30,2008 and 2007***

 

*Revenues from Continuing Operations*

 

Revenues from continuingoperations were $1.0 million for the three months ended September 30, 2008compared to $0.3 million for the third quarter of fiscal 2007.  Ourrevenues for the three month period include $0.9 million from our contract withthe United States Department of Defense to develop Prochymal for the treatmentof acute radiation syndrome, plus $0.1 million in royalties on MSCs sold forresearch purposes.  Revenues from continuing operations for the threemonths ended September 30, 2007 were $0.3 million, and consisted primarilyof the recognition of unearned revenue from a license agreement that was terminatedin December 2007.

 

*Researchand Development Expenses*

 

Research and developmentexpenses for the three months ended September 30, 2008 were $18.6 million,and were $0.4 million lower than our research and development expenses for thesecond quarter of fiscal 2008.  Research and development expenses for thethree months ended September 30, 2007 were $10.8 million.  Theincrease in these expenses compared to the prior year reflects the increase inour clinical trial activities.  At September 30, 2008, we wereconducting three Phase III clinical trials in several inflammatory diseaseindications, and Phase II clinical trials for acute myocardial infarction, type1 diabetes mellitus, and COPD.  In addition, we were conducting Phase IIIclinical trials under the animal rule on 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.

 

*Generaland Administrative Expenses (excluding discontinued operations)*

 

General and administrativeexpenses were $1.9 million for the three months ended September 30, 2008compared to $1.3 million for the comparable period in fiscal 2007.  Theincrease in general and administrative expenses is primarily attributable toincreases in our professional staff in the areas of intellectual property andbusiness development and increases in legal costs related to our intellectualproperty 

 

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portfolio. Also, during thethird quarter of 2008, we closed our Baltimore, Maryland manufacturing facilityupon the expiration of our lease for this facility.

 

*InterestExpense, Net*

 

Interest expense, net was$0.4 million for the three months ended September 30, 2008 compared to$0.3 million in the corresponding period in fiscal 2007.  In June andJuly 2008, we issued an aggregate of $6.5 million of short-term promissorynotes, which accrue interest at 10% semi-annually and are due and payable in December 2008. We repaid $2.5 million of this short-term debt in September 2008 andexpect to retire the remaining $4.0 million of short-term debt prior to December 31,2008.

 

***Comparison of the Nine Months ended September 30, 2008 and 2007***

 

*Revenuefrom Continuing Operations*

 

Revenues from continuingoperations for the nine months ended September 30, 2008 were $3.9 millioncompared to $0.9 million in the comparable period of fiscal 2007.  Our fiscal2008 revenues include $2.0 million in milestone revenue from the collaborativeagreement with JDRF, $1.7 million in contract revenue from our contract withthe DoD, and $0.2 million of royalty revenue.  Our revenues in thecomparable period of fiscal 2007 consisted of $0.8 million in license fees froman agreement with an international pharmaceutical company which was terminatedin December 2007, and $0.1 million of royalty revenue.

 

*Researchand Development Expenses*

 

Research and developmentexpenses for the nine months ended September 30, 2008 were $54.3 millioncompared to $29.8 million for the nine months ended September 30,2007.  The approximately 82% increase in research and development expensesin 2008 as compared to 2007 is consistent with our business plan and reflectsthe substantial increase in our clinical trial activities and activitiesrelated to the pending filing of our biologic license application with the FDA,as we anticipate commercialization of Prochymal.

 

*Generaland Administrative Expenses*

 

General and administrativeexpenses for the nine months ended September 30, 2008 were $6.3 millioncompared to $4.3 million in the comparable period of fiscal 2007.  Theincrease in 2008 includes increased legal costs incurred to protect and defendour intellectual property portfolio and increases in our management staff inanticipation of qualifying and commercializing Prochymal.

 

*InterestExpense, Net*

 

Interest expense, net was$0.8 million for the first nine months of fiscal 2008 compared to $1.1 millionfor the comparable period of fiscal 2007.

 

  ***Income (Loss) from Operations ofDiscontinued Operations***

 

Loss from operations of theOsteocel asset disposal group was $0.4 million for the three months ended September 30,2008 compared to earnings of $1.8 million for the comparable period of fiscal2007, and income of $6.3 million for the nine months ended September 30,2008 compared to earnings of $2.0 million for the comparable period of fiscal2007, as follows:

 

| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Product Sales                                             |       | $                                | 2,872      |                            | $          | 4,003 |   | $ | 19,338 |   | $ | 9,255 |   |
| Cost of goods sold                                        |       | 3,035                            |       | 1,826                           |       | 11,602 |   | 4,230 |   |
| Gross Profit                                              |       | (163                             | )          | 2,177                           |       | 7,736 |   | 5,025 |   |
|                                                      |       |                             |       |                            |       |   |   |   |   |
| Failed production runs                                    |       | —                           |       | 246                             |       | — |   | 2,679 |   |
| Selling, general & administrative  expenses      |       | 221                              |       | 149                             |       | 1,467 |   | 395 |   |
|                                                      |       | 221                              |       | 395                             |       | 1,467 |   | 3,074 |   |
|                                                      |       |                             |       |                            |       |   |   |   |   |
| Income (loss) from operations of  discontinued operations |       | $                                | (384       | )                               | $          | 1,782 |   | $ | 6,269 |   | $ | 1,951 |   |

 

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In April 2008, wecommitted to a plan to sell our biologic tissue business, consisting of theOsteocel asset disposal group.  On May 8, 2008 we entered into anAsset Purchase Agreement for the sale of the Osteocel asset disposal group toNuVasive, Inc., and on July 24, 2008, the “technology assets closing”occurred and we received a $35.0 million payment.  As discussed in Note 4to the Condensed Financial Statements included in this Quarterly Report on Form 10-Q,we have the opportunity to receive up to an additional $50.0 million inmilestone payments related to the sale of this business unit.

 

During the third quarter of2008, we recognized a gain of $25.5 million on the sale of the Osteoceldisposal group at the technology assets closing. We incurred transaction costsof $1.4 million, including legal, accounting and advisory fees.  We also established reserves totaling $8.1million to recognize concessionary pricing of Osteocel to be produced under theManufacturing Agreement, as amended. These reserves will be amortized into the income (loss) from operationsof discontinued operations through the end of 2009, concurrent with ourfulfillment of our obligations under the Manufacturing Agreement.  At September 30, 2008, $4.3 millionof these reserves are included in current liabilities of discontinuedoperations and $0.9 million are recorded as long-term liabilities of discontinuedoperations.

 

Concurrent with thetechnology assets closing, we entered into a Manufacturing Agreement withNuVasive under which we will continue to manufacture Osteocel for up to18-months and sell 100% of the product to NuVasive at specified prices. ThisManufactuiring Agreement has since been amended in part.  NuVasive has certain minimum purchase orderobligations under the Manufacturing Agreement.  We could recognize up toapproximately $40 million in additional revenue from discontinued operationsunder the Manufacturing Agreement, but we do not expect to report significant,if any, profits from manufacturing the product under this agreement.

 

**Liquidity and Capital Resources**

 

***Liquidity***

 

Thecurrent global financial crisis – which has included, among other things,significant reductions in available capital and liquidity from banks and otherproviders of credit, substantial reductions and/or fluctuations in equity andcurrency values worldwide, significant decreases in consumer confidence and consumerand business spending, and concerns that the worldwide economy may enter into aprolonged recessionary period – may materially adversely affect our access tocapital.  In addition, the current global financial crisis may materiallyadversely affect the liquidity and access to capital of parties with which wefrom time to time collaborate, which may in turn adversely impact their abilityor desire to participate or perform under their collaborations with us. These potential effects of the current global financial crisis are difficult toforecast and mitigate. Should additional capital be required to pursue ourbusiness plan, but not be available, as a result of the global economic crisisor otherwise, our business and financial condition would be materially andadversely affected.

 

At September 30, 2008,we had $10.6 million in cash and investments available for sale.  Ourinvestments available for sale consist of investment grade student loan auctionrate certificates which are scheduled to be redeemed at par value during November 2008and January 2009.

 

In July 2008, weentered into an Asset Purchase Agreement with NuVasive for the sale of ourOsteocel business unit and received $35.0 million concurrent with the “technologyassets closing.”  The Purchase Agreementprovides for up to $50.0 million in future milestone payments and we expect toreceive the first $5.0 million milestone payment during or before the firstquarter of 2009. These milestone payments become payable beginning in the firstquarter of 2009, assuming that certain conditions to payment aresatisfied.  There can be no assurance that we will successfully completeany or all of the events which will trigger any of the milestonepayments.  Concurrent with the technology assets closing, we entered intoa Manufacturing Agreement with NuVasive whereby we will continue to manufactureOsteocel for up to 18-months for the exclusive sale to NuVasive at specifiedprices.  We understand that NuVasive intends to distribute Osteocel toBlackstone Medical and others in accordance with the terms of certainpreexisting and amended agreements.

 

In October 2008, weentered into a Collaboration Agreement with Genzyme that provides fornon-contingent, non-refundable initial payments of $75.0 million, to be receivedby us in November 2008 and $55.0 million to be received by us on July 1,2009.

 

During the nine months endedSeptember 30, 2008, we have issued $10.5 million in convertible promissorynotes and an additional $6.5 million of short-term promissory notes to non-USaccredited investors.

 

At September 30, 2008,our short-term debt consisted of $1.6 million payable during 2008 to amultinational pharmaceutical company, $6.5 million in short-term notes due December 2008,and $8.0 million of convertible promissory notes which mature on November 30,2008.  The notes provide for redemption with prior notice at ouroption.  The convertible notes may be converted into common stock at anytime at the discretion of the note holders, and may be redeemed at our option atany time upon thirty days prior notice.

 

In October 2007, weobtained a $30.0 million financing commitment from Friedli Corporate Finance, Inc.,which is owned by Peter Friedli, the Chairman of our Board of Directors andlargest shareholder. This financing commitment was for a twelve-month term andprovided for financing through the issuance by us of either common stock at aprice determined as the basis of market value, or promissory notes.  This financing commitment expired in October 2008.

 

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***Cash Flows***

 

Net cash used in operatingactivities of continuing operations was $31.1 million for the three monthsended September 30, 2008, primarily reflecting our loss from continuingoperations of $19.9 million, partially offset by $0.9 million of non-cashcharges and increased by $12.1 million of unfavorable working capital changes,consisting primarily of the $12.7 million decrease in accounts payable andaccrued expenses. During the third quarter of fiscal 2007, net cash used inoperating activities of continuing operations was $10.4 million, consisting ofour loss from continuing operations of $12.2 million, partially offset bynon-cash charges of $0.8 million and net favorable variances in working capitalof $0.9 million.

 

Net cash provided byoperating activities of discontinued operations was $5.2 million for the threemonths ended September 30, 2008, which reflects the income fromdiscontinued operations of $25.2 million (comprised of the gain on the sale ofdiscontinued operations, net of transaction costs of $25.5 million and the lossfrom the operations of discontinued operations of $0.4 million), less the $28.0million gain from sale of discontinued operations, net of non-cash charges,partially offset by favorable changes in working capital of $7.8 million. Net cash provided by operating activities of discontinued operations for thethree months ended September 30, 2007 was $1.5 million, which is made upof the income from continuing operations of $1.8 million offset by $0.3 millionof unfavorable working capital.

 

Net cash provided byinvesting activities was $33.4 million for the three months ended September 30,2008, consisting of $33.6 million of proceeds from the sale of discontinuedoperations (net of $1.4 million of transaction costs), partially offset by $0.4million of fixed asset additions, and the receipt of $0.1 million in proceedsfrom the sale of used equipment in connection with the closing of ourBaltimore, Maryland manufacturing facility.  The fixed asset additions areprimarily related to the move of our Osteocel manufacturing operations to ourColumbia, Maryland facility.  At the end of the third quarter, we closedour Baltimore manufacturing facility at the expiration of the lease. Net cashprovided by investing activities during the third quarter of fiscal 2007 was$9.1 million, including $1.9 million of capital expenditures, offset by the saleof $11.0 million of our investments available for sale.

 

Net cash used in financingactivities was $4.6 million for the three months ended September 30, 2008,representing the payment of $6.0 million of principal payments on ourshort-term debt and capital lease obligations, proceeds from the issuance of$1.0 million in short-term notes payable, and $0.3 million proceeds from theexercise of stock options.  During the third quarter of fiscal 2007, netcash used in financing activities was $0.4 million, which primarily resultedfrom the scheduled payments on our capital lease obligations.

 

Net cash used in operatingactivities of continuing operations was $57.9 million for the nine months endedSeptember 30, 2008, reflecting our loss from continuing operations of$57.5 million, which was partially offset by $2.9 million of non-cash chargesand $3.2 million of unfavorable working capital changes, consisting primarilyof decreases in our accounts payable and accrued expenses.  Net cash usedin operating activities of continuing operations for the nine months ended September 30,2007 was $33.1 million, reflecting our loss from continuing operations of $34.3million, partially offset by non-cash charges of $2.6 million and netunfavorable working capital changes of $1.4 million.

 

Net cash provided by theoperations of discontinued operations was $11.3 million for the nine monthsended September 30, 2008, reflecting income from discontinued operationsof $31.8 million, partially offset by the $28.0 million gain on sale ofdiscontinued operations (net of non-cash charges), $0.5 million of non-cashcharges and $7.0 million of favorable changes in working capital.  Netcash provided by discontinued operations for the nine months ended September 30,2007 was $1.3 million, which is comprised of income from discontinuedoperations of $2.0 million, offset by unfavorable changes in working capital.

 

Net cash provided byinvesting activities for the nine months ended September 30, 2008 was$42.1 million and consisted of proceeds from the sale of discontinuedoperations, net of transactions costs of $33.6 million, the sale of investmentsavailable for sale of $12.4 million netted against capital expenditures of $4.0million.  The capital expenditures are related primarily to the build-outof our Osteocel manufacturing facilities at our Columbia, Maryland location,and to related equipment purchases.  Net cash provided by investingactivities for the nine months ended September 30, 2007 was $12.9 million,which represented $4.2 million of capital expenditures offset by net sale ofour investments available for sale of $17.1 million.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2008 was $9.1million, consisting of borrowings of $10.5 million of convertible promissorynotes and $6.5 million of short-term promissory notes, netted against paymentsof $4.9 million on a promissory note we issued in December 2007, $2.5million of short-term notes issued during 2008 and payments on our capitalleases.  Net cash provided by financing activities for the nine monthsended September 30, 2007 was $18.7 million, primarily reflecting theproceeds of the $20.0 million private placement of our common stock andscheduled payments on our capital leases.

 

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Tableof Contents

 

***Capital Resources***

 

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

 

·                                                             the achievement of the milestone eventsrelated to the Genzyme Collaboration Agreement for the development andcommercialization of Prochymal and Chondrogen;

 

·                                                             the achievement of the milestone eventsrelated to the sale of the Osteocel business unit and performance under therelated manufacturing agreement;

 

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

 

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

 

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

 

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

 

·                                                             the costs of repaying our debt; and

 

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

 

As a result of these andother factors, we may choose to seek additional funding prior to our becomingcash flow positive on an operational basis.  We would likely seek suchfunding through public or private financings or some combination of them. We might also seek funding through additional collaborative arrangements ifdetermined to be necessary or appropriate.

 

Additional funding may notbe available to us on acceptable terms, or at all.  If we obtain capitalfunding through collaborative arrangements, these arrangements could require usto relinquish rights to our technologies or biologic drug candidates.  Ifwe raise capital through the sale of equity, or securities convertible intoequity, dilution to our then existing stockholders would result.  If weraise additional capital through the incurrence of debt, we would likely becomesubject to covenants restricting our business activities, and holders ofdebt instruments would have rights and privileges senior to those of ourequity investors.  In addition, servicing the interest and repaymentobligations under these borrowings would divert funds that would otherwise beavailable to support research and development, clinical or commercializationactivities.

 

We expect that our availablecash and interest income, together with the $130.0 million payable to us inaccordance with the terms of our collaboration agreement with Genzyme, and themilestone payments available to be earned by us under this collaborationagreement and under the Asset Purchase Agreement with NuVasive, would, iftimely received by us in full, be sufficient to fund our operations through theexpected commercialization of Prochymal for at least one of the indicationsthat are currently in Phase III clinical trials.  We expect to receivepayment in full from Genzyme of the $130.0 million as and when due, but themilestone payments available to be earned from Genzyme and NuVasive are subjectto various terms and conditions, including termination and opt out rights inthe case of Genzyme and other matters largely beyond our control, leading tosignificant uncertainty as to whether these payments will ever bereceived.  Accordingly, if we are notsuccessful for any reason in earning or receiving these milestone payments inwhole or in part, we may be required to seek additional funding before we areable to commercialize Prochymal for these indications.  In addition, estimates with regard to oursources and uses of funds and the path to commercialization of our productcandidates are based on numerous assumptions, which are inherently imprecise.  These assumptions, and our ability to earn orreceive any payments due to or otherwise available to us, could be negativelyimpacted by any of the matters discussed under “Risk Factors” in this QuarterlyReport on Form 10-Q or our Annual Report on Form 10-K, among otherthings.

 

If additional funds arerequired but not available, we may be required to delay, reduce the scope of,or eliminate one or more of our research and development programs, which mayhave a material adverse affect on our business, financial condition and resultsof operations.  See “Risk Factors” in this Quarterly Report on Form 10-Qand our Annual Report on Form 10-K.

 

**Off-Balance Sheet Arrangements.**

 

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

 

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**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 fornon-collectability and establishment of appropriate allowances in connectionwith our internal controls 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 September 30,2008 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**.

 

In addition to the risk factors previously disclosedunder the heading “Risk Factors” in Part I – Item 1A of our Annual Reporton Form 10-K for the fiscal year ended December 31, 2007, filed withthe Securities and Exchange Commission on March 17, 2008 and disclosedunder the heading “Risk Factors” in Part II – Item 1A of our QuarterlyReport for the quarterly period ended March 31, 2008, filed with theSecurities and Exchange Commission on May 12, 2008, you should carefullyconsider the risk factors described below which relate to our collaborativeagreements.  If any of the following riskfactors or any of the risk factors set forth in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2007 or our Quarterly Report on Form 10-Qfor the quarterly period ended March 31, 2008 actually occur, ourbusiness, financial condition or results of operations could be materiallyadversely affected.

 

**We usethird-party collaborators to help us develop and commercialize our products,and our ability to commercialize such products may be impaired or delayed ifcollaborations are unsuccessful.**

 

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

 

· we are party to a Collaboration Agreementwith Genzyme for the development and commercialization of Prochymal andChondrogen outside the United States and Canada for certain indications, andwith the potential for the development and commercialization of these productcandidates for additional indications in the future;

 

· we are party to a Manufacturing Agreementwith NuVasive, Inc. for the manufacture and supply by us to NuVasiveof Osteocel on an interim basis and until the “Manufacturing Assets Closing”occurs under the Asset Purchase Agreement between us and NuVasive, pursuant towhich we sold our Osteocel and Osteocel XC lines of business to NuVasive;

 

· we have a collaboration with JCRPharmaceuticals Co., Ltd. granting to JCR an exclusive right to Prochymal forthe treatment of GvHD in Japan; and

 

· we have a collaboration with GenzymeCorporation to develop effective countermeasures to nuclear terrorism and otherradiological emergencies. The initial focus of the collaboration is to developProchymal to treat the potentially lethal complications of acute radiationsyndrome.

 

We may enter intoadditional collaborations in the future. We are dependent upon the success ofour current and any future collaborators in performing their responsibilities.If we fail to maintain these collaborative relationships for any reason, wewould need to undertake on our own and at our own expense, or find othercollaborators, to perform the activities we currently anticipate will beperformed by our collaborators.  This would substantially increase ourcash requirements.  We may not have the capability or financial capacityto undertake these activities on our own, or we may not be able to find othercollaborators on acceptable terms, or at all.  This may limit the programswe are able to pursue and result in significant delays in the development, saleand manufacture of our products, and may have a material adverse effect on ourbusiness.

 

We are subject toa number of risks associated with our dependence upon our collaborativerelationships, including :

 

·our collaborators may not cooperate with us or performtheir obligations under our agreements with them;

 

·we cannot control the amount and timing of ourcollaborators’ resources that will be devoted to performing theirresponsibilities under our agreements with them, and our collaborators maychoose to pursue alternative technologies in preference to those beingdeveloped in collaboration with us;

 

·refusal to or failure of our collaborators to performtheir responsibilities in a timely manner, including breach;

 

·the right of the collaborator to terminate itscollaboration agreement with us for reasons outside our control, and in somecases on limited notice;

 

·business combinations and changes in a collaborator’sbusiness strategy may adversely affect the party’s willingness or ability tocomplete its obligations;

 

·loss of significant rights to our collaborativeparties if we fail to meet our obligations;

 

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·disagreements as to ownership of clinical trialresults or regulatory approvals;

 

·withdrawal of support by a collaborator followingdevelopment or acquisition by the collaborator of competing products; and

 

·disagreements with a collaborator regarding thecollaboration agreement or ownership of intellectual property or otherproprietary rights.

 

Due to these factors andother possible events, we could suffer delays in the research, development orcommercialization of our products or we may become involved in litigation orarbitration, which would be time consuming and expensive.

 

**Two ofour most significant collaborative arrangements are with Genzyme Corporation,and our ultimate success may depend upon performance on the part of Genzyme andthe success of these collaborations.**

 

We are party to twocollaborative arrangements with Genzyme, one for the development andcommercialization of Prochymal and Chondrogen outside the United States andCanada for certain indications, and the otherto develop effective countermeasures to nuclearterrorism and other radiological emergencies.   These collaborationsare subject to all of the risks and uncertainties applicable to collaborativearrangements generally, including those described above.  In addition,these collaborations are subject to a number of risks and uncertaintiesspecific to the transactions and the parties.

 

Under our collaborativearrangement with Genzyme for commercialization of Prochymal and Chondrogenoutside the United States, Genzyme is obligated to make two up front paymentsto us: an initial payment of $75.0 million and an additional payment of $55.0million on July 1, 2008.  In addition, we have the opportunity toearn up to an additional $1.25billionin milestone payments.  Receipt of these additionalmilestone payments is conditioned upon the achievement of the applicabledevelopment, regulatory and sales milestones, all of which are subject to allof the risks and uncertainties otherwise applicable to our business, includingthe success of Prochymal and Chondrogen.  Genzyme has the right toterminate the collaboration at any time after July 1, 2009.  Genzymealso has the right to “opt-out” of further participation with regard toChondrogen development, whereupon all rights to Chondrogen will revert to us,but our opportunity to earn Chondrogen-related development, regulatory andsales milestone of up to approximately $500.0 million will cease. The success of this collaboration for us will in part be dependent uponGenzyme, including determinations regarding the exercise of its termination andopt out rights, and its success in obtaining timely regulatory approvals forthe marketing of products outside of the United States, and ability to generatesales sufficient to trigger milestone and royalty payments to us.

 

Under our collaborativearrangement with Genzyme for the development of effective countermeasures tonuclear terrorism and other radiological emergencies, we were awarded in January 2008a contract from the U.S. Department of Defense to develop and supply Prochymalfor acute radiation syndrome (ARS). We are carrying out this contract inpartnership with Genzyme, with us contributing Prochymal and our correspondingsafety and advocacy database to the effort, and with Genzyme lending its massproduct development and large scale commercialization expertise.

 

Genzyme has significantlygreater resources than we do, and these collaborations are not as core to itsbusiness, as they are to ours.  We are dependent upon Genzyme’s continuedperformance under these collaborations, and any determination by Genzyme not toproceed or perform, or any material adverse event that affects Genzyme’sability or desire to perform, under either of these collaborations may have amaterial adverse effect on our business.

 

**Item 2.**                                                           **Unregistered Sales ofEquity Securities and Use of Proceeds**.

 

 None.

 

**Item 3.**                                                           **Defaults Upon SeniorSecurities**.

 

 None.

 

**Item 4.**                                                           **Submission of Matters toa Vote of Security Holders**.

 

We held a Special Meeting of Stockholders on July 24,2008 to seek approval of the sale of our Osteocel business to NuVasive, Inc.under the terms and conditions of the Asset Purchase Agreement dated as of May 8,2008, by and between us and NuVasive, Inc.  Of the 31,770,555 sharesof common stock outstanding as of the record date of the Special Meeting,20,287,831, or 63.4% of the total shares eligible to vote, were represented inperson or by proxy.  One proposal was submitted to our stockholders andapproved at the Special Meeting as follows:

 

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*Approval of the Asset PurchaseAgreement and the Transactions Contemplated Thereby. * The Asset Purchase Agreement and thetransactions contemplated thereby were approved by our stockholders as follows:

 
| FOR              |   | 20,242,224 |   |
|------------------|--------|------------|--------|
| AGAINST          |   | 11,389     |   |
| ABSTAIN          |   | 34,218     |   |
| BROKER NON-VOTES |   | 0          |   |

 

**Item 5.**                                                           **Other Information**.

 

None.

 

###### **Item 6. Exhibits.**

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                       |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                       |
| 10.1+               |       | Manufacturing Agreement, dated as of July 24,  2008, by and between Osiris Therapeutics, Inc. and NuVasive, Inc.                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                       |
| 10.2+               |       | Amendment to Manufacturing Agreement, dated as of  September 30, 2008, by and between Osiris Therapeutics, Inc. and  NuVasive, Inc.                                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                       |
| 10.3+               |       | Amendment to Asset Purchase Agreement, dated as of  September 30, 2008, by and between Osiris Therapeutics, Inc. and  NuVasive, Inc.                                                                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                       |
| 10.4                |       | Employment Agreement by and between Osiris  Therapeutics, Inc. and Richard W. Hunt entered into as of July 23,  2008 (incorporated herein by reference to Exhibit 10.1 to the Current  Report on Form 8-K filed by Osiris Therapeutics, Inc. with the  Securities and Exchange Commission on July 29, 2008). |
|                |       |                                                                                                                                                                                                                                                                                                                                       |
| 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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+                                         Confidentialportions omitted and filed separately with the United States Securities andExchange Commission pursuant to Rule 24b-2 promulgated under theSecurities Exchange Act of 1934, as amended.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 
| ** **                   | **Osiris Therapeutics, Inc.**                        |
|------------------------------|-----------------------------------------------------------|
|                         |                                                      |
| Date: November 10, 2008 | /s/ RICHARD W. HUNT                                       |
|                         | Richard W. Hunt                                           |
|                         | Chief Financial Officer (Principal Financial  Officer)    |
|                         |                                                      |
| Date: November 10, 2008 | /s/ PHILIP R. JACOBY, JR.                                 |
|                         | Philip R. Jacoby, Jr.                                |
|                         | Vice President of Finance (Principal Accounting  Officer) |

 

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