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 June 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 mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

| 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 August 7,  2008** |
|-------------------------------------------|------------|---------------------------------------------------|
| Common  Stock, par value $0.001 per share |       | 31,808,030                                        |

 

 

 

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**OSIRIS THERAPEUTICS, INC.**

**INDEX**

 
| **PART I —  FINANCIAL INFORMATION** | 3                                                                                                        |
|-----------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                    | ** **                                                                                               | ** ** |
| Item 1.                                       | Financial  Statements — Unaudited.                                                                  | 3 |
|                                          | Condensed  Balance Sheets — June 30, 2008 and December 31, 2007.                          | 3 |
|                                          | Condensed  Statements of Operations — three and six months ended June 30, 2008 and  2007.      | 4 |
|                                          | Condensed  Statement of Stockholders’ (Deficit) Equity — six months ended June 30,  2008. | 5 |
|                                          | Condensed Statements of Cash Flows — six months ended  June 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.             | 13 |
|                                          |                                                                                                     |   |
| Item 3.                                       | Quantitative  and Qualitative Disclosures About Market Risk.                                             | 20 |
|                                          |                                                                                                     |   |
| Item 4.                                       | Controls and  Procedures.                                                                                | 20 |
|                                          |                                                                                                     |   |
| **PART II — OTHER  INFORMATION**    | 21                                                                                                       |
|                                          |                                                                                                     |   |
| Item 1.                                       | Legal Proceedings.                                                                                       | 21 |
| Item 1A.                                 | Risk Factors.                                                                                            | 21 |
| Item 2.                                       | Unregistered  Sales of Equity Securities and Use of Proceeds.                                            | 21 |
| Item 3.                                       | Defaults Upon  Senior Securities.                                                                        | 21 |
| Item 4.                                       | Submission of  Matters to a Vote of Security Holders.                                                    | 21 |
| Item 5.                                       | Other Information.                                                                                       | 22 |
| Item 6.                                       | Exhibits.                                                                                                | 22 |
|                                          |                                                                                                     |   |
| Signatures                                    |                                                                                                     | 23 |
|                                          |                                                                                                     |   |
| Exhibit Index                            |                                                                                                     |   |

 

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**PART I— FINANCIAL INFORMATION**

 

**Item 1.****                                                          ****Financial Statements -Unaudited**.

 

**OSIRIS THERAPEUTICS, INC.**

**Condensed Balance Sheets**

**Unaudited**

**Amounts in thousands**

 
| ** **                                                                                                      | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                      | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                      |       |                    |       |                        |       |
| Current assets:                                                                                                 |       |                    |       |                        |       |
| Cash                                                                                                            |       | $                       | 2,353      |                        | $          | 704 |   |
| Investments available for sale                                                                                  |       | 4,662                   |       | 17,460                      |       |
| Accounts receivable                                                                                             |       | 1,544                   |       | 549                         |       |
| Prepaid expenses and other current assets                                                                       |       | 2,097                   |       | 1,583                       |       |
| Current assets of discontinued operations                                                                       |       | 10,675                  |       | 8,445                       |       |
| Total current assets                                                                                            |       | 21,331                  |       | 28,741                      |       |
|                                                                                                            |       |                    |       |                        |       |
| Property and equipment, net                                                                                     |       | 1,032                   |       | 2,020                       |       |
| Restricted cash                                                                                                 |       | 280                     |       | 280                         |       |
| Other assets                                                                                                    |       | 825                     |       | 1,404                       |       |
| Long-term assets of discontinued operations                                                                     |       | 8,172                   |       | 4,596                       |       |
| Total assets                                                                                                    |       | $                       | 31,640     |                        | $          | 37,041 |   |
|                                                                                                            |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ (DEFICIT) EQUITY**                                                        |       |                    |       |                        |       |
| Current liabilities:                                                                                            |       |                    |       |                        |       |
| Accounts payable and accrued expenses                                                                           |       | $                       | 21,271     |                        | $          | 11,535 |   |
| Notes payable, current portion                                                                                  |       | 18,391                  |       | 6,521                       |       |
| Capital lease obligations, current portion                                                                      |       | 283                     |       | 886                         |       |
| Current liabilities of discontinued  operations                                                                 |       | 3,974                   |       | 2,552                       |       |
| Total current liabilities                                                                                       |       | 43,919                  |       | 21,494                      |       |
|                                                                                                            |       |                    |       |                        |       |
| Note payable, net of current portion                                                                            |       | 2,500                   |       | 1,200                       |       |
| Other long-term liabilities                                                                                     |       | 16                      |       | 11                          |       |
| Total liabilities                                                                                               |       | 46,435                  |       | 22,705                      |       |
|                                                                                                            |       |                    |       |                        |       |
| Stockholders’ (deficit) equity:                                                                            |       |                    |       |                        |       |
| Common stock, $0.001 par value, 90,000  shares authorized 31,771 and 31,648 shares outstanding in 2008 and 2007 |       | 32                      |       | 32                          |       |
| Additional paid-in-capital                                                                                      |       | 258,197                 |       | 255,728                     |       |
| Accumulated other comprehensive loss                                                                            |       | (632                    | )          | —                      |       |
| Accumulated deficit                                                                                             |       | (272,392                | )          | (241,424                    | )          |
| Total stockholders’ (deficit) equity                                                                       |       | (14,795                 | )          | 14,336                      |       |
| Total liabilities and stockholders’  (deficit) equity                                                      |       | $                       | 31,640     |                        | $          | 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 June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Revenue from government contracts,  collaborative research agreements and royalties |       | $                                                   | 2,530      |                                              | $          | 295 |   | $ | 2,892 |   | $ | 574 |   |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Operating expenses:                                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Research and development                                                            |       | 19,048                                              |       | 10,440                                            |       | 35,742 |   | 18,934 |   |
| General and administrative                                                          |       | 1,782                                               |       | 1,501                                             |       | 4,390 |   | 3,007 |   |
| Total operating expenses                                                            |       | 20,830                                              |       | 11,941                                            |       | 40,132 |   | 21,941 |   |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Loss from operations                                                                |       | (18,300                                             | )          | (11,646                                           | )          | (37,240 | ) | (21,367 | ) |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense, net                                                               |       | (172                                                | )          | (418                                              | )          | (381 | ) | (761 | ) |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Loss from continuing operations                                                     |       | (18,472                                             | )          | (12,064                                           | )          | (37,621 | ) | (22,128 | ) |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Income from operations of discontinued  operations                                  |       | 3,104                                               |       | 1,606                                             |       | 6,653 |   | 169 |   |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Net loss                                                                            |       | $                                                   | (15,368    | )                                                 | $          | (10,458 | ) | $ | (30,968 | ) | $ | (21,959 | ) |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Basic and diluted net loss per share                                                |       |                                                |       |                                              |       |   |   |   |   |
| Loss from continuing operations                                                     |       | $                                                   | (0.58      | )                                                 | $          | (0.43 | ) | $ | (1.19 | ) | $ | (0.80 | ) |
| Income from discontinued operations                                                 |       | 0.10                                                |       | 0.06                                              |       | 0.21 |   | 0.01 |   |
| Net loss                                                                            |       | $                                                   | (0.48      | )                                                 | $          | (0.37 | ) | $ | (0.98 | ) | $ | (0.79 | ) |
|                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Weighted Average Common Shares (basic and  diluted)                                 |       | 31,769                                              |       | 27,914                                            |       | 31,754 |   | 27,649 |   |

 

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 six months ended June 30, 2008**

**Unaudited**

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

 
| ** **                                                                      | ** ** | ** **            | ** ** | ** **              | ** ** | ** **               | ** ** | **Accumulated** | ** ** | ** **                    | ** ** | ** **                | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|--------------------------|------------|-----------------|------------|-------------------------------|------------|---------------------------|------------|
| ** **                                                                      | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Other  Comprehensive** | ** ** | **Accumulated** | ** ** | **Total  Stockholders’** | ** ** |
| ** **                                                                      | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**              | ** ** | **Loss**        | ** ** | **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 - $0.80 per share)    |       | 13,069                |       | —                  |       | 5                        |       | —          |       | —                        |       | 5                         |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Issuance of common stock for services  rendered by directors ($12.01 per share) |       | 21,500                |       | —                  |       | 258                      |       | —          |       | —                        |       | 258                       |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Share-based payment — employee compensation                                |       | —                |       | —                  |       | 706                      |       | —          |       | —                        |       | 706                       |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| **Comprehensive Loss:**                                                         |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Net loss for the period                                                         |       | —                |       | —                  |       | —                   |       | —          |       | (30,968                       | )          | (30,968                   | )          |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| Unrealized loss on investments available  for sale                              |       | —                |       | —                  |       | —                   |       | (632            | )          | —                        |       | (632                      | )          |
| **Total Comprehensive Loss**                                                    |       |                  |       |                    |       |                     |       |            |       |                          |       | (31,600                   | )          |
|                                                                            |       |                  |       |                    |       |                     |       |            |       |                          |       |                      |       |
| **Balance at June 30, 2008**                                               |       | 31,770,530            |       | $                       | 32         |                     | $          | 258,197         |       | $                             | (632       | )                         | $          | (272,392 | ) | $ | (14,795 | ) |

 

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**

 
| ** **                                                                                               | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
|                                                                                                     |       |                                              |       |   |   |
| **Cash flows from operating activities:**                                                                |       |                                              |       |   |   |
| **Continuing Operations:**                                                                               |       |                                              |       |   |   |
| Loss from continuing operations                                                                          |       | $                                                 | (37,621    | ) | $ | (22,128 | ) |
| **Adjustments to reconcile loss from  continuing operations to net cash used in continuing operations:** |       |                                              |       |   |   |
| Depreciation and amortization                                                                            |       | 940                                               |       | 821 |   |
| Non cash share-based payments                                                                            |       | 887                                               |       | 827 |   |
| Non cash interest expense                                                                                |       | 130                                               |       | 120 |   |
| **Changes in operating assets and  liabilities:**                                                        |       |                                              |       |   |   |
| Accounts receivable                                                                                      |       | (995                                              | )          | 75 |   |
| Prepaid expenses and other current assets                                                                |       | (513                                              | )          | (107 | ) |
| Other assets                                                                                             |       | 560                                               |       | 328 |   |
| Accounts payable and accrued expenses                                                                    |       | 9,736                                             |       | (2,334 | ) |
| Deferred revenue                                                                                         |       | —                                            |       | (476 | ) |
| Long-term interest payable and other  liabilities                                                        |       | 9                                                 |       | 200 |   |
| Net cash used in continuing operations                                                                   |       | (26,867                                           | )          | (22,674 | ) |
| **Discontinued Operations:**                                                                             |       |                                              |       |   |   |
| Income from discontinued operations                                                                      |       | 6,653                                             |       | 169 |   |
| **Adjustments to reconcile income to net cash  provided by (used in) discontinued operations:**          |       |                                              |       |   |   |
| Depreciation and amortization                                                                            |       | 149                                               |       | 52 |   |
| Non cash share-based payments                                                                            |       | 78                                                |       | 22 |   |
| **Changes in operating assets and  liabilities:**                                                        |       |                                              |       |   |   |
| Accounts receivable                                                                                      |       | (1,684                                            | )          | (561 | ) |
| Inventory and other current assets                                                                       |       | (546                                              | )          | (95 | ) |
| Accounts payable and accrued expenses                                                                    |       | 1,422                                             |       | 204 |   |
| Net cash provided by (used in) discontinued  operations                                                  |       | 6,072                                             |       | (209 | ) |
| Net cash used by operating activities                                                                    |       | (20,795                                           | )          | (22,883 | ) |
|                                                                                                     |       |                                              |       |   |   |
| **Cash flows from investing activities:**                                                                |       |                                              |       |   |   |
| Purchases of property and equipment                                                                      |       | (3,676                                            | )          | (2,322 | ) |
| Proceeds from sale of investments available  for sale                                                    |       | 12,353                                            |       | 24,797 |   |
| Purchases of investments available for sale                                                              |       | —                                            |       | (18,730 | ) |
| Net cash provided by investing activities                                                                |       | 8,677                                             |       | 3,745 |   |
|                                                                                                     |       |                                              |       |   |   |
| **Cash flows from financing activities:**                                                                |       |                                              |       |   |   |
| Principal payments on capital lease  obligations and notes payable                                       |       | (2,238                                            | )          | (584 | ) |
| Restricted cash                                                                                          |       | —                                            |       | 11 |   |
| Proceeds from convertible and short-term  notes payable                                                  |       | 16,000                                            |       | — |   |
| Proceeds from issuance of common stock                                                                   |       | 5                                                 |       | 20,059 |   |
| Payment of debt financing fees                                                                           |       | —                                            |       | (400 | ) |
| Net cash provided by financing activities                                                                |       | 13,767                                            |       | 19,086 |   |
|                                                                                                     |       |                                              |       |   |   |
| Net increase in cash                                                                                     |       | 1,649                                             |       | (52 | ) |
| Cash at beginning of period                                                                              |       | 704                                               |       | 714 |   |
|                                                                                                     |       |                                              |       |   |   |
| **Cash at end of period:**                                                                               |       | $                                                 | 2,353      |   | $ | 662 |   |

 

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

 

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

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

 

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

 

Theaccompanying unaudited condensed financial statements of Osiris Therapeutics, Inc.(the “Company”) have been prepared in accordance with generally acceptedaccounting principles in the United States and the rules and regulationsof the United States Securities and Exchange Commission (the “SEC”), forinterim financial information.  Accordingly, they do not include all theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements and should be read in conjunction with theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31,2007.  The interim financial statements are unaudited, but in the opinionof management all adjustments, consisting only of normal recurring accruals,considered necessary for a fair statement of the results of these interimperiods have been included.  The interimfinancial statements for the three and six months ended June 30, 2007 andthe balance sheet at December 31, 2007 have been reclassified to report ourOsteocel business unit as discontinued operations, as discussed in Note 3 tothese condensed financial statements. The results of the Company’s operations for any interim period are notnecessarily indicative of the results that may be expected for any otherinterim period or for a full fiscal year.

 

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

 

***Use of Estimates***

 

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

 

***Revenue Recognition***

 

Ourrevenue recognition policies are in accordance with SEC Staff AccountingBulletin No. 101, *Revenue Recognitionin Financial Statements*, as amended by SEC Staff Accounting BulletinNo. 104, *Revenue Recognition*.

 

InJanuary 2008, we were awarded a contract from the United States Departmentof Defense (“DoD”) pursuant to which we are seeking to develop and stockpileProchymal for the repair of gastrointestinal injury resulting from radiationexposure.  We began recognizing revenueunder this contract during the first quarter of fiscal year 2008.  Contractrevenue is recognized as the related costs are incurred, in accordance with theterms of the contract.  During the threemonths ended June 30, 2008, we recognized $0.5 million in revenue from theDoD contract.

 

InOctober 2007, we entered into a collaborative agreement with the JuvenileDiabetes Research Foundation (“JDRF”) to conduct a Phase II clinical trialevaluating Prochymal as a treatment for type 1 diabetes.  This collaborative agreement provides forJDRF to provide up to $4.0 million in funding to support the development ofProchymal for the preservation of insulin production in patients with newlydiagnosed type 1 diabetes mellitus. During the three months ended June 30, 2008, we recognized $2.0million in revenue upon the achievement of certain milestones delineated in ouragreement with JDRF.

 

***Loss per Common Share***

 

Basicloss per common share is calculated by dividing net loss by the weightedaverage number of common shares outstanding during the period.  Diluted loss per common share adjusts basicloss per share for the potentially dilutive effects of common shareequivalents, using the treasury stock method. All common share equivalents resulting from assumed conversion ofconvertible debt and outstanding stock options and warrants are excluded fromthe computation of diluted loss per share as their effect is antidilutive.

 

***Investments Available for Sale***

 

Investments Available for Sale consist primarily ofinvestment grade auction rate certificates. They are valued at estimated fair value, with unrealized gains andlosses reported as a separate component of stockholders’ equity in AccumulatedOther Comprehensive Loss.

 

Securities available for sale are evaluatedperiodically to determine whether a decline in their value is “other than temporary.”  The term “other than temporary” is notintended to indicate a permanent 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.  Managementreviews criteria such as the magnitude and duration of the decline, as well asthe reasons for the decline, to predict 

 

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

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

 

whetherthe loss in value is other than temporary. Once a decline in value is determined to be other than temporary, thevalue of the security is reduced and a corresponding charge to earnings isrecognized. Our investments available for sale at June 30, 2008 consist ofinvestment grade student loan auction rate certificates that are presentlyilliquid at par value.  The collateralfor these securities is guaranteed by agencies of the United States; however,because of the current turmoil in the credit markets, these securities cannotpresently be sold at par value.

 

***Stock-Based Compensation Plans***

 

In1994, we adopted the Amended and Restated 1994 Stock Incentive Plan (the “1994Plan”) under which 875,000 shares of common stock have been reserved forissuance upon the exercise of options or other equity grants that we issue fromtime to time.  In 2006, we adopted the 2006 Omnibus Plan, under which weinitially reserved 850,000 shares of common stock for issuance upon theexercise of stock options or other equity grants.  At our annual meeting of stockholders held onJune 4, 2008, our stockholders approved our Amended and Restated 2006Omnibus Plan, pursuant to which our 2006 Omnibus Plan was amended and restatedto, among other things, increase the number of shares available for grant atany time thereunder by 600,000 shares from 850,000 to 1,450,000.  We stopped granting options under the 1994Plan upon the completion of our initial public offering in August 2006.

 

Asummary of the combined activity under both of our stock-based compensationplans as of June 30, 2008 and changes during the six months then ended ispresented below.

 
| ** **                            | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price Per Share  at Grant Date** | ** ** | **Weighted Average  Remaining Term  (in Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding at December 31, 2007 |       | 880,410                    |       | $                                                                                           | 8.64       |                                                            | 7.2        |                                | $          | 5,091 |   |
| Granted                               |       | 336,000                    |       | 12.08                                                                                       |       |                                                            |       |                                |       |
| Exercised                             |       | (13,069                    | )          | 0.41                                                                                        |       |                                                            |       | 150                                 |       |
| Forfeited or expired                  |       | (88,375                    | )          | 12.35                                                                                       |       |                                                            |       |                                |       |
| Outstanding at June 30, 2008     |       | 1,114,966                  |       | 9.48                                                                                        |       | 8.0                                                             |       | 5,401                               |       |
|                                  |       |                       |       |                                                                                        |       |                                                            |       |                                |       |
| Exercisable at June 30, 2008     |       | 415,641                    |       | 3.87                                                                                        |       | 7.0                                                             |       | 4,142                               |       |
|                                       |            |                            |            |                                                                                             |            |                                                                 |            |                                     |            |  |  |

 

Theweighted average grant date fair value of options granted during the six monthsended June 30, 2008 was $7.91 per share.  We received a total of $5 in cash from theexercise of options during the six months ended June 30, 2008.

 

Alsoduring the six months ended June 30, 2008, we granted 21,500 unrestrictedshares of common stock to members of our Board of Directors under our 2006Omnibus Plan and recognized $258 in share-based expense.  As of June 30,2008, 717,760 shares of common stock remain available for future grants underour 2006 Omnibus Plan, as recently amended and restated.

 

Share-basedcompensation (including director compensation) included in our statements ofoperations for the three and six months ended June 30, 2008 and 2007 isallocable to our biologic drug candidate business, discontinued operations andgeneral administrative activities, as follows:

 
| ** **                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Biologic drug candidates   |       | $                                                   | 101        |                                              | $          | 186 |   | $ | 330 |   | $ | 330 |   |
| Discontinued operations    |       | 38                                                  |       | 13                                                |       | 79 |   | 22 |   |
| General and administrative |       | 151                                                 |       | 121                                               |       | 555 |   | 497 |   |
| Total                      |       | $                                                   | 290        |                                              | $          | 320 |   | $ | 964 |   | $ | 849 |   |

 

Asof June 30, 2008, there was approximately $5.2 million of totalunrecognized share-based compensation cost related to options granted under ourplans which will be recognized over a weighted-average period of approximately3.5 years.

 

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

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

 

***Supplemental Cash Flow Information***

 
| ** **                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| **Supplemental  disclosure of cash flows information:**                    |       |                                          |       |   |   |
| Cash paid for interest                                                     |       | $                                             | 305        |   | $ | 1,190 |   |
| 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 New Accounting Pronouncements***

 

On December 12, 2007,the Financial Accounting Standards Board, or FASB, ratified the consensusreached by the Emerging Issues Task Force, or EITF, on EITF Issue No. 07-1,*“Accounting for Collaborative Arrangements,”*or EITF 07-1.  EITF 07-1 definescollaborative arrangements and establishes reporting requirements fortransactions between participants in a collaborative arrangement and betweenparticipants in the arrangement and third parties.  EITF 07-1 is effective for financialstatements issued for fiscal years beginning after December 15, 2008.  We are currently evaluating the impact ofadopting EITF 07-1 on our financial statements and cannot estimate theimpact of adoption at this time.

 

On June 27, 2007, theFASB ratified the consensus reached by the EITF on EITF Issue No. 07-3, “*Accounting for Nonrefundable Advance Payments for Goods or Services toBe Used in Future Research and Development Activities,*” orEITF 07-3.  EITF 07-3 requirescompanies to defer and capitalize prepaid, nonrefundable research anddevelopment payments to third parties, and amortize them over the period thatthe research and development activities are performed or the services areprovided, subject to an assessment of recoverability.  EITF 07-3 is effective for new contractsentered into during fiscal years beginning after December 15, 2007,including interim periods within those fiscal years.  We adopted EITF 07-3 in the first quarter of2008.  There was no material impact onour financial statements upon adoption.

 

In September 2006, theFASB issued Statement of Financial 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. 157is effective for financial statements 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 5 to the Condensed FinancialStatements.

 

In February 2007, theFASB issued SFAS No. 159, *“The Fair Value Option forFinancial Assets and Financial Liabilities—including an amendment of FASBStatement No. 115.”* SFAS No. 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value.  Entities that elect the fair value optionwill report unrealized gains and losses in earnings at each subsequentreporting date. The fair value option may be elected on aninstrument-by-instrument basis, with few exceptions.  SFAS No. 159 also establishespresentation and disclosure requirements to facilitate comparisons betweencompanies that choose different measurement attributes for similar assets andliabilities.  SFAS No. 159 iseffective for fiscal years beginning after November 15, 2007.  We elected not to adopt the fair value optionof SFAS No. 159 at this time.

 

InMarch 2008, the FASB issued SFAS No. 161, *“Disclosures about Derivative Instruments and HedgingActivities—an amendment of FASB Statement No. 133.*”  SFAS No. 161 will require entities toprovide qualitative disclosures about the objectives and strategies for usingderivatives, quantitative disclosures about the fair value of gains and losseson derivative contracts, and disclosures about credit-risk related tocontingent features in their hedged positions. The statement also asks entities to disclose more information about (i) thelocation and amounts of derivative instruments in financial statements; (ii) howderivatives and related hedges are accounted for under SFAS No. 133; and (iii) howthe hedges affect the entity’s financial position, financial performance andcash flows.  The statement is effectivefor fiscal years and interim periods beginning after November 15, 2008, withearly application encouraged, but not required. As of March 31, 2008 we have not adopted SFAS No. 161.  We do not expect the adoption of SFAS No. 161to have a material impact on our financial statements.

 

**3.****                                                                                     ****Discontinued Operations &Subsequent Event**

 

InApril 2008, we committed to a plan to sell our biologic tissue productbusiness, including our entire product line relating to the processing,manufacturing, marketing and selling of Osteocel® and Osteocel® XO, anallograft material containing cancellous bone, used in spinal fusion and othersurgical procedures.  We refer to these assets as our Osteocel assetdisposal group.  Not included among the Osteocel asset disposal group isOsteocel® XC, our second generation product candidate under development forbone repair, utilizing culture expanded mesenchymal stem cells to create asynthetic version of Osteocel.  On May 8, 2008, we entered into anAsset Purchase Agreement to sell the Osteocel asset disposal group to NuVasive, Inc.,a Delaware corporation.  The agreementprovides for the sale to be effected at two closings — 

 

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

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

 

a technology assets closing,at which technology and certain other business assets are transferred, and amanufacturing assets closing, at which manufacturing assets and facilities aretransferred.  On July 24, 2008, we held a Special Meeting ofStockholders at which our stockholders overwhelmingly approved the sale of theOsteocel business.  The technology assetsclosing also occurred on that date, at which time we received an initialpayment of $35.0 million.  Themanufacturing assets closing is expected to occur approximately 18 months afterthe date of the technology assets closing.

 

TheAsset Purchase Agreement provides for up to $50.0 million of contingent additionalpayments to us upon our achievement of milestone events, in addition to the$35.0 million initial payment, as follows:

 
| ** **                                        | ** ** | ** ** | ** ** | **Cut-Off**       | ** **                 |
|---------------------------------------------------|------------|------------|------------|-------------------|----------------------------|
| **Milestone**                                     | ** ** | **Amount** | ** ** | **Date**          | ** **                 |
| Initial payment                                   |       | $          | 35,000     |              | Received in July 2008 |   |
|                                              |       |       |       |              |                       |
| Cumulative sales to NuVasive of 125,000  units(1) |       | 5,000      |       | April 2009   |                       |
| Cumulative sales to NuVasive of 250,000  units    |       | 5,000      |       | January 2010 |                       |
| Net end-user sales of $35 million                 |       | 15,000     |       | none              |                       |
| Cumulative sales to NuVasive of 275,000  units    |       | 5,000      |       | January 2010 |                       |
| Cumulative sales to NuVasive of 308,300  units    |       | 2,500      |       | January 2010 |                       |
| Cumulative sales to NuVasive of 366,600  units    |       | 2,500      |       | January 2010 |                       |
| Cumulative sales to NuVasive of 424,900  units    |       | 2,500      |       | January 2010 |                       |
| Transfer of Manufacturing Assets                  |       | 12,500     |       | January 2010 |                       |
|                                              |       |       |       |              |                       |
| Total possible purchase price                     |       | $          | 85,000     |              |                       |   |

 

----

(1)Each unit represents 1.0 cubic centimeter of Osteocel product.

 

Ifand when the requisite milestone events occur, we will recognize the milestoneproceeds as a component of gain (loss) from the sale of discontinuedoperations.  We expect to recognize again on the initial payment during the third quarter of 2008.

 

Concurrentwith the technology assets closing, we entered into a Manufacturing Agreementwith NuVasive, Inc., under which we will continue to manufacture Osteocelfor up to 18-months and sell 100% of the product to NuVasive at specifiedprices.  NuVasive has certain minimumpurchase order obligations under the Manufacturing Agreement.  We could recognize up to approximately $52.0million in revenue from discontinued operations under the ManufacturingAgreement, but do not expect to report significant, if any, profits frommanufacturing the product under this Agreement.

 

Thenet assets allocable to the Osteocel asset disposal group at June 30, 2008and December 31, 2007 were as follows:

 
| ** **                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Accounts receivable                             |       | $        | 6,009      |     | $          | 4,324 |   |
| Inventory                                       |       | 4,471    |       | 3,983    |       |
| Other current assets                            |       | 195      |       | 138      |       |
|                                            |       |     |       |     |       |
| Current assets of discontinued operations       |       | 10,675   |       | 8,445    |       |
|                                            |       |     |       |     |       |
| Property and equipment, net                     |       | 8,172    |       | 4,596    |       |
|                                            |       |     |       |     |       |
| Current liabilities of discontinued  operations |       | (3,974   | )          | (2,552   | )          |
|                                            |       |     |       |     |       |
| Net assets of discontinued operations           |       | $        | 14,873     |     | $          | 10,489 |   |

 

Weeliminated the Osteocel asset disposal group from our ongoing operations as aresult of the disposal transaction and have presented the results of the group’soperations as a discontinued operation for all periods.  Summarized operating results of the Osteocelasset disposal group are as follows:

 

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

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

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                           | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Product Sales                                        |       | $                                | 8,955      |                           | $          | 3,252 |   | $ | 16,466 |   | $ | 5,252 |   |
| Cost of goods sold                                   |       | 4,786                            |       | 1,503                          |       | 8,567 |   | 2,404 |   |
| Gross Profit                                         |       | 4,169                            |       | 1,749                          |       | 7,899 |   | 2,848 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Failed production runs                               |       | —                           |       | —                         |       | — |   | 2,433 |   |
| Selling, general & administrative  expenses |       | 1,065                            |       | 143                            |       | 1,246 |   | 246 |   |
|                                                 |       | 1,065                            |       | 143                            |       | 1,246 |   | 2,679 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Income from operations of discontinued  operations   |       | $                                | 3,104      |                           | $          | 1,606 |   | $ | 6,653 |   | $ | 169 |   |

 

 

**4.****                                                                                     ****Notes Payable**

 

InDecember 2007, we issued a short-term promissory note to an internationalpharmaceutical company in the principal amount of $6,521.  This note bears interest at 8% and is due ininstallment payments during 2008.  Wepaid $1,630, plus accrued interest during the three months ended March 31,2008, and then paid $3,260, plus accrued interest in July 2008.  This note will be paid in full prior to December 31,2008.

 

InMarch and May 2008, we issued an aggregate of $10.5 million inconvertible promissory notes to several non-U.S. investors pursuant to aprivate placement intended to qualify under Regulation S and Section 4(2) ofthe Securities Act of 1933, as amended. Three of these notes with anaggregate principal amount of $8.0 million bear interest at 2% and become dueand payable on November 30, 2008. The fourth note with a principal amount of $2.5 million bearsinterest at 4% and becomes due and payable on November 30, 2009. The notesare convertible at the option of the respective holders at any time, intoshares of our common stock at conversion prices ranging from $12.04 to $13.18per share (the respective closing prices on the NASDAQ Global Exchange on thedates of the definitive agreements). The notes provide for redemption at anytime at our option, with 30-days prior written notice.  The note holdersare afforded certain registration rights in respect of any shares issued uponconversion.

 

InJune 2008, we issued an aggregate of $5.5 million in short-term notes toseveral non-U.S. investors pursuant to a private placement intended to qualifyunder Regulation S and Section 4(2) of the Securities Act of 1933, asamended.  These notes bear interest at10% semi-annually and become due and payable in December 2008.  The notes are not convertible but areredeemable at our option with ten days prior written notice, upon any monthlyanniversary of the date of issuance.  Weexpect to repay these short-term notes from the proceeds of the initial closingprice of the sale of our Osteocel business.

 

**5.****                                                                                     ****Fair Value**

 

In September 2006, theFASB issued Statement No. 157, *FairValue Measurements,*or**SFAS157.  SFAS 157 establishes a standard framework for measuring fair valuein generally accepted accounting principles, clarifies the definition of “fairvalue” within that framework, and expands disclosures about the use of fairvalue measurements.  We adopted SFAS 157 in the first quarter of 2008with regard to all financial assets and liabilities in our financial statementsgoing forward, and, consistent with FASB Staff Position 157-2, *“Effective Date of FASB Statement No. 157,”* we haveelected to delay the adoption of SFAS 157 for non-financial assets andliabilities not recognized or disclosed at fair value on a recurring basisuntil the first quarter of 2009. See below for a further discussion.  The adoption of SFAS 157 had no materialimpact on our financial statements.

 

Fair value is defined as theprice at which an asset could be exchanged or a liability transferred (an exitprice) in an orderly transaction between knowledgeable, willing parties in theprincipal or most advantageous market for the asset or liability.  Where available, fair value is based onobservable market prices or parameters or derived from such prices orparameters.  Where observable prices orinputs are not available, valuation models are applied.

 

Financialassets recorded at fair value in the Condensed Financial Statements arecategorized based upon the level of judgment associated with the inputs used tomeasure their fair value.  Hierarchicallevels, defined by SFAS 157 and directly related to the amount of subjectivityassociated with the inputs to fair valuation of these assets and liabilities,are as follows:

 

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

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

 

*Level 1* —Inputs are unadjusted, quoted prices in active markets for identical assets atthe reporting date.  Active markets are those in which transactions forthe asset or liability occur in sufficient frequency and volume to providepricing information on an ongoing basis.

 

The fair valued assets we hold that are generallyincluded in this category are money market securities where fair value is basedon publicly quoted prices.

 

*Level 2* —Inputs are other than quoted prices included in Level 1, which are eitherdirectly or indirectly observable for the asset or liability throughcorrelation with market data at the reporting date and for the duration of theinstrument’s anticipated life.

 

The fair valued assets we hold that are generallyincluded in this category are investment grade auction rate certificates andcommercial paper where fair value is based on valuation methodologies such asmodels using observable market inputs, such as benchmark yields, reportedtrades, broker/dealer quotes, bids, offers and other reference data.

 

*Level 3* —Unobservable inputs that are supported by little or no market activity and thatare significant to the fair value of the assets or liabilities and whichreflect management’s best estimate of what market participants would use inpricing the asset or liability at the reporting date. Consideration is given tothe risk inherent in the valuation technique and the risk inherent in theinputs to the model.

 

Wecarry no investments classified as Level 3.

 

Assets and liabilities measured at fair value on a recurringbasis are summarized below:

 
| ** **                            | **Fair value measurements at June 30, 2008 using** | ** ** |
|---------------------------------------|---------------------------------------------------------------------------------------|------------|
| ** **                            | ** **                                                                            | ** ** | **Quoted prices in  active markets for  identical assets** | ** ** | **Significant other  observable  inputs** | ** ** | **Significant  unobservable  inputs** | ** ** |
| ** **                            | **June 30, 2008**                                                           | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Assets:                               |                                                                                  |       |   |   |   |   |   |   |
| Overnight Securities included in Cash | $                                                                                     | 1,900      |   | $ | 1,900 |   | $ | — |   | $ | — |   |
| Investments available for sale        | 4,662                                                                                 |       | — |   | 4,662 |   | — |   |
|                                       |                                                                                       |            |  |  |  |  |  |  |  |  |  |  |

 

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**Item 2.****  Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

 

**Forward-Looking Information**

 

Thisreport includes “forward-looking statements” within the meaning of Section 21Eof the Securities Exchange Act of 1934, or the Exchange Act. Forward-lookingstatements include statements concerning our plans, objectives, goals,strategies, future events, future revenues or performance, capitalexpenditures, compensation arrangements, financing needs, plans or intentionsrelating to acquisitions, business trends and other information that is nothistorical information and, in particular, may appear under the headings “RiskFactors” in our Annual Report 10-K under Part I—Item 1A, “Part II—Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations” and the other documents wefile with the United States Securities and Exchange Commission, or SEC,including, among others, our quarterly reports on Form 10-Q and anyamendments thereto.  When used in thisQuarterly Report, the words *estimates,expects, anticipates, projects, plans, intends, believes, forecasts*and variations of such words or similar expressions are intended to identifyforward-looking statements.  Examples offorward-looking statements include, but are not limited to, statementsregarding the following: our product development efforts; our clinical trialsand anticipated regulatory requirements; the success of our product candidatesin development; status of the regulatory process for our biologic drugcandidates; implementation of our corporate strategy; our financialperformance; our product research and development activities and projectedexpenditures, including our anticipated timeline and clinical strategy formesenchymal stem cells and biologic drug candidates; our cash needs; patentsand proprietary rights; ability of our potential products to treat disease; ourplans for sales and marketing; our plans regarding facilities; types of regulatoryframeworks we expect will be applicable to our potential products; results ofour scientific research; and our ability to benefit from the sale of ourOsteocel business and to earn milestone payments and perform under and deriverevenue from the related manufacturing agreement.  All forward-looking statements, including,without limitation, management’s examination of historical operating trends,are based upon our current expectations and various assumptions.  Our expectations, beliefs and projections areexpressed in good faith and we believe there is a reasonable basis for them.However, there can be no assurance that management’s expectations, beliefs orprojections will result or be achieved and you should not unduly rely onforward-looking statements.

 

Youshould read the following management’s discussion and analysis of our financialcondition and results of operations in conjunction with our audited FinancialStatements and related notes thereto and other disclosures included as part ofour Annual Report on Form 10-K for the year ended December 31, 2007,and our unaudited Condensed Financial Statements for the three and six monthsended June 30, 2008 and other disclosures included in this QuarterlyReport on Form 10-Q.  Our CondensedFinancial Statements have been prepared in accordance with U.S. generallyaccepted accounting principles and are presented in U.S. dollars.

 

Thereare a number of risks and uncertainties that could cause our actual results todiffer materially from the forward-looking statements contained in this report.Some of the important factors that could cause our actual results to differmaterially from the forward-looking statements we make in this report are setforth in our Annual Report on Form 10-K for the fiscal year ended December 31,2007 under Part I — Item 1A “Risk Factors,” and in our Quarterly Report onForm 10-Q for the fiscal quarter ended March 31, 2008 under Part II– Item 1A “Risk Factors.”  There may beother factors that may cause our actual results to differ materially from theforward-looking statements.

 

Allforward-looking statements attributable to us or persons acting on our behalfapply only as of the date of this Quarterly Report and are expressly qualifiedin their entirety by the cautionary statements included herein.  We undertake no obligation to publicly updateor revise any forward-looking statements to reflect subsequent events orcircumstances and do not intend to do so.

 

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

 

**Introduction and Overview**

 

Thefollowing is a discussion and analysis of our financial condition and resultsof operations for the three and six month periods ended June 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.”

 

Weare a leading stem cell therapeutic company headquartered in Columbia,Maryland, focused on developing and marketing products to treat medicalconditions in the inflammatory, orthopedic, and cardiovascular areas.  We were incorporated in Delaware in April 2002.  Our predecessor company was organized in1992.  Our lead biologic drug candidate,Prochymal®, is being evaluated in Phase III clinical trials for threeindications, including acute and steroid refractory Graft versus Host Disease (“GvHD”)and Crohn’s disease, and is the only stem cell therapeutic currently grantedboth Orphan Drug and Fast Track status by the Food and Drug Administration (“FDA”).  Prochymal is also being developed for therepair of heart tissue following a heart attack, the protection of pancreaticislet cells in patients with type 1 diabetes, and the treatment ofpatients with chronic obstructive pulmonary disease.  Our pipeline of internally developed biologicdrug candidates under evaluation also includes Chondrogen® for osteoarthritisin the knee.  We have partnered withGenzyme Corporation to develop Prochymal as a medical countermeasure to nuclearterrorism and other radiological emergencies. We have also partnered with the Juvenile Diabetes Research Foundationfor the development of Prochymal as a treatment for the preservation of insulinproduction in patients with newly diagnosed type 1 diabetes mellitus.

 

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Weare a fully integrated company, having developed capabilities in research,development, manufacturing, marketing and distribution of stem cell products.We have developed an extensive intellectual property portfolio to protect ourtechnology in the United States and a number of foreign countries, including 47U.S. and 255 foreign patents owned or licensed. We believe that our biologic drug candidates have advantages over otherstem cell therapeutics in development for the 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.

 

Thefollowing table summarizes key information about our biologic drug candidates.

 
| **Product/Candidate** | ** ** | **Indication**                                  | ** ** | **Status**              | ** ** |
|-----------------------|------------|-------------------------------------------------|------------|-------------------------|------------|
| **Prochymal**         |       | Steroid Refractory Acute GvHD    | ** ** | Phase III          | ** ** |
|                  |       | First Line Treatment of Acute GvHD              |       | Phase III          |       |
|                  |       | Biologics Refractory Crohn’s Disease       |       | Phase III          |       |
|                  |       | Type I Diabetes                            |       | Phase II           |       |
|                  |       | Acute Myocardial Infarction                     |       | Phase II           |       |
|                  |       | Chronic Obstructive Pulmonary Disease           |       | Phase II                |       |
|                  |       | Acute Radiation Syndrome                        |       | Phase III (Animal Rule) |       |
| ** **            |       |                                            |       |                    |       |
| **Chondrogen**        |       | Osteoarthritis & Cartilage  Protection |       | Phase II/III       |       |

 

**Financial Operations Overview**

 

*Revenue*

 

Werecognize revenue on collaborative and royalty agreements and a contract withthe United States Department of Defense for the development and stockpiling ofProchymal for the treatment of acute radiation syndrome.  Our collaborative agreement with the JuvenileDiabetes Research Foundation provides for funding of up to $4.0 million insupport of developing Prochymal as a treatment for the preservation of insulinproduction in patients with newly diagnosed type 1 diabetes mellitus.  We recognize revenue on this collaborativeagreement when we achieve the specified milestone events.  During the three months ended June 30,2008, we recognized $2.0 million in revenue upon the achievement of certainmilestones under this collaborative agreement.

 

*Research and Development Costs*

 

Ourresearch and development costs consist of expenses incurred in identifying,developing and testing biologic drug candidates. These expenses consistprimarily of salaries and related expenses for personnel, fees paid toprofessional service providers for independentmonitoring and analysis of our clinicaltrials, costs of contract research and manufacturing, costs of facilities, andthe costs of manufacturing clinical batches of biologic drug candidates,quality control supplies and material to expand biologic drug candidates.

 

Consistentwith our focus on the development of biologic drug candidates with potentialuses in multiple indications, many of our costs are not attributable to aspecifically identified project.  We useour employee and infrastructure resources across several projects.  Accordingly, we do not account for internalresearch and development costs on a project-by-project basis.  As a result, we cannot state 

 

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precisely the total costsincurred for each of our clinical and preclinical projects on aproject-by-project basis.  From inceptionin December 1992 through June 30, 2008, we incurred aggregateresearch and development costs of approximately $270 million.

 

Weexpect our research and development expenses to increase substantially in thefuture, as we expand our clinical trial activity, as our biologic drugcandidates advance through the development cycle and as we invest in additionalproduct opportunities and research programs. Clinical trials and preclinical studies are time-consuming andexpensive.  Our expenditures on currentand future preclinical and clinical development programs are subject to manyuncertainties.  We test our products inseveral preclinical studies, and we then conduct clinical trials for thosebiologic drug candidates that we determine to be the most promising.  As we obtain results from clinical trials, wemay elect to discontinue or delay trials for some biologic drug candidates inorder to focus our resources on more promising biologic drug candidates.  Completion of clinical trials may take severalyears or more, but the length of time generally varies substantially accordingto the type, size of trial and intended use of a biologic drug candidate.  The cost of clinical trials may varysignificantly over the life of a project as a result of 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;

 

·                                                               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.

 

Asa result of the uncertainties discussed above, we are unable to determine withany significant degree of certainty the duration and completion costs of ourresearch and development projects or when and to what extent we will generaterevenues from the commercialization and sale of any of our biologic drugcandidates.

 

Wehave incurred annual operating losses since inception and expect to incursubstantial operating losses in the future in connection with the developmentof our core products. As of June 30, 2008, we had an accumulated deficitof $272.5 million.

 

*General and Administrative Expenses*

 

Generaland administrative expenses consist primarily of the costs associated with ourgeneral management, including salaries, allocations of facilities and relatedcosts, and professional fees such as legal and accounting expenses. Inanticipation of commercialization and bringing our biologic drug candidates tomarket, we are incurring increases in our general and administrative expense inthe areas of business development and intellectual property.  We have alsoincurred increased general and administrative costs for legal and accountingcompliance costs, investor relations and other activities associated withoperating as a publicly traded company. Continued increases will also likely result from the additional hiringof operational, financial, accounting, facilities engineering and informationsystems personnel.

 

*InterestExpense, Net*

 

Interestincome consists of interest earned on our cash and short-term investments.Interest expense consists of interest incurred on convertible debt, capitalleases and other debt financings.  We payinterest on our short-term loans, capital leases and our convertible long-termdebt.

 

*Income Taxes*

 

Wehave not recognized any deferred tax assets or liabilities in our financialstatements since we cannot assure their future realization. Because realizationof deferred tax assets is dependent upon future earnings, a full valuationallowance has been recorded on the net deferred tax assets, which relateprimarily to net operating loss and research and development carry-forwards. Inthe event that we become profitable within the next several years, we have netdeferred tax assets of approximately $80 million that may be utilized prior tous having to recognize any income tax expense or make payments to the taxingauthorities.  Utilization of our netoperating loss carry-forwards in any one year may be limited under InternalRevenue Code Section 382, and we could be subject to the alternativeminimum tax.

 

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**CriticalAccounting Policies**

 

Therehave been no material changes in our critical accounting policies, estimatesand judgments during the six months ended June 30, 2008 compared to thedisclosures in Part II, Item 7 of our Annual Report on Form 10-Kfor the year ended December 31, 2007, other than as disclosed herein.

 

**Results of Operations**

 

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

 

*Revenues from Continuing Operations*

 

Revenuesfrom continuing operations were $2.5 million for the three months ended June 30,2008 compared to $0.3 million for the second quarter of fiscal 2007.  Our revenues for the three month periodinclude $2.0 million of milestone revenue from the Juvenile Diabetes ResearchFoundation (“JDRF”), as provided for in our collaborative agreement for the developmentof Prochymal as a treatment for the preservation of insulin production inpatients with newly diagnosed type 1 diabetes. Revenues for the three month period also include $0.5 million in revenuerecognized on our contract with the United States Department of Defense for thedevelopment of Prochymal as a medical countermeasure to nuclear terrorism andother radiological emergencies, and $0.1 million in royalty revenue.  Revenues from continuing operations for thethree months ended June 30, 2007 were $0.3 million, and consistedprimarily of the recognition of unearned revenue from a license agreement thatwas terminated in December 2007.

 

*Research and Development Expenses*

 

Researchand development expenses for the three months ended June 30, 2008 were$19.0 million, and were $2.3 million higher than our research and developmentexpenses for the first quarter of fiscal 2008. Research and development expenses for the three months ended June 30,2007 were $10.4 million.  The increase inthese expenses compared to the prior year and the first quarter of fiscal 2008reflect the increase in our clinical trial activities.  At June 30, 2008, we were conductingthree Phase III clinical trials in several inflammatory disease indications,and Phase II clinical trials for acute myocardial infarction, type 1 diabetesand chronic obstructive pulmonary disease. In addition, we were conducting preclinical research on acute radiationsyndrome.  The increased clinical trialactivities have increased the demand for clinical batches of our biologic drugcandidates and we have experienced increased costs in our contractmanufacturing activities.  We are alsoincurring research and development expenses in connection with the preparationof our biologic license application as we prepare filings with the FDA towardsthe commercialization of Prochymal.

 

*General and AdministrativeExpenses (excluding discontinued operations)*

 

Generaland administrative expenses were $1.8 million for the three months ended June 30,2008 compared to $1.5 million for the comparable period in fiscal 2007.  The increase in general and administrativeexpenses is primarily attributable to increases in our professional staff inthe areas of intellectual property and business development.

 

*Interest Expense, Net*

 

Interestexpense, net was $0.2 million for the three months ended June 30, 2008compared to $0.4 million in the corresponding period in fiscal 2007.  In June 2008, we issued $5.5 million ofshort-term promissory notes, which accrue interest at 10% semi-anually and aredue and payable in December 2008. Accordingly, we expect our interest expense, net to increase during theremainder of the current fiscal year.

 

***Comparison of the SixMonths ended June 30, 2008 and 2007***

 

*Revenue from Continuing Operations*

 

Revenuesfrom continuing operations for the six months ended June 30, 2008 were$2.9 million compared to $0.6 million in the comparable period of fiscal2007.  Our fiscal 2008 revenues include$2.0 million in milestone revenue from the collaborative agreement with JDRF,$0.8 million in contract revenue from contracts with the United StatesDepartment of Defense and $0.1 million of royalty revenue.  Our revenues in the comparable period offiscal 2007 consisted of $0.5 million in license fees from an agreement with aninternational pharmaceutical company which was terminated in December 2007,and $0.1 million of royalty revenue.

 

*Research and Development Expenses*

 

Research and developmentexpenses for the six months ended June 30, 2008 were $35.7 millioncompared to $18.9 million for the six months ended June 30, 2007.  The approximately 89% increase in researchand development expenses in 2008 as compared to 2007 is 

 

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consistent with our businessplan and reflect the substantial increase in our clinical trial activities andactivities related to the pending filing of our biologic license applicationwith the FDA, as we approach commercialization of Prochymal.

 

*General and AdministrativeExpenses*

 

General and administrativeexpenses for the six months ended June 30, 2008 were $4.4 million comparedto $3.0 million in the comparable period of fiscal 2007.  The increase in 2008 includes legal costsincurred to protect and defend our intellectual property portfolio andincreases in our management staff in anticipation of qualifying andcommercializing Prochymal.

 

*Interest Expense, Net*

 

Interest expense, net was$0.4 million for the first six months of fiscal 2008 compared to $0.8 millionfor the comparable period of fiscal 2007.

 

 ***Incomefrom Operations of Discontinued Operations***

 

Income from operations ofthe Osteocel asset disposal group was $3.1 million for the three months ended June 30,2008 compared to earnings of $1.6 million for the comparable period of fiscal2007, and $6.7 million for the six months ended June 30, 2008 compared toearnings of $0.2 million for the comparable period of fiscal 2007, as follows:

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                           | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Product Sales                                        |       | $                                | 8,955      |                           | $          | 3,252 |   | $ | 16,466 |   | $ | 5,252 |   |
| Cost of goods sold                                   |       | 4,786                            |       | 1,503                          |       | 8,567 |   | 2,404 |   |
| Gross Profit                                         |       | 4,169                            |       | 1,749                          |       | 7,899 |   | 2,848 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Failed production runs                               |       | —                           |       | —                         |       | — |   | 2,433 |   |
| Selling, general & administrative  expenses |       | 1,065                            |       | 143                            |       | 1,246 |   | 246 |   |
|                                                 |       | 1,065                            |       | 143                            |       | 1,246 |   | 2,679 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Income from operations of discontinued  operations   |       | $                                | 3,104      |                           | $          | 1,606 |   | $ | 6,653 |   | $ | 169 |   |

 

InApril 2008, we committed to a plan to sell our biologic tissue productpractice, consisting of the Osteocel asset disposal group.  On May 8, 2008 we entered into an AssetPurchase Agreement for the sale of the Osteocel asset disposal group to NuVasive, Inc.,and on July 24, 2008, the “technology assets closing” occurred and wereceived a $35.0 million payment.  Asdiscussed in Note 3 to the Condensed Financial Statements included in thisQuarterly Report on Form 10-Q, we have the opportunity to receive up to anadditional $50.0 million in milestone payments related to the sale of thisbusiness unit.

 

Concurrentwith the technology assets closing, we entered into a Manufacturing Agreementwith NuVasive under which we will continue to manufacture Osteocel for up to18-months and sell 100% of the product to NuVasive at specified prices.  NuVasive has certain minimum purchase orderobligations under the Manufacturing Agreement. We could recognize up to approximately $52.0 million in additionalrevenue from discontinued operations under the Manufacturing Agreement, but wedo not expect to report significant, if any, profits from manufacturing theproduct under this agreement.

 

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**Liquidity and Capital Resources**

 

***Liquidity***

 

AtJune 30, 2008, we had $7.0 million in cash and investments available forsale.  Our investments available for saleconsist of investment grade auction rate certificates which are presentlyilliquid at par value.  As discussed morefully in Item 3 – Quantitative and Qualitative Disclosures About Market Risk inthis Quarterly Report on Form 10-Q, we recorded an unrealized loss on thefair value of these investments of $0.6 million during the three months ended June 30,2008, as other comprehensive loss.  Thefair value of our auction rate securities could change significantly based onmarket conditions and continued uncertainties in the credit markets.  Our portfolio managers are presently unableto provide us with an estimate of how long the credit crisis in the auctionrate certificate market will exist. Estimating the fair value of investments in auction rate certificatesrequires numerous assumptions and are inherently subjective.  There can be no assurance as to when themarket for auction rate securities will stabilize and the fair value of ourauction rate securities could change significantly based on market conditionsand continued uncertainties in the credit markets.

 

InOctober 2007, we obtained a $30.0 million financing commitment fromFriedli Corporate Finance, Inc., which is owned by Peter Friedli, theChairman of our Board of Directors and largest shareholder.  This financing commitment is for a twelvemonth term and provides for financing through the issuance by us of eithercommon stock at a price determined as the basis of market value, or promissorynotes.  During the six months ended June 30,2008, we have issued $10.5 million in convertible promissory notes and anadditional $5.5 million of short-term promissory notes, separate from thisfinancing commitment.

 

AtJune 30, 2008, our short-term debt consisted of $4.9 million payableduring 2008 to an international pharmaceutical company, $5.5 million inshort-term notes due December 2008, and $8.0 million of convertiblepromissory notes which mature on November 30, 2008.  The notes provide for redemption with priornotice at our option.  The convertiblenotes may be converted into common stock at any time at the discretion of thenote holders, and may be redeemed at our option at any time upon thirty daysprior notice.

 

OnJuly 24, 2008, at a Special Meeting of Stockholders, our Stockholdersapproved the Asset Purchase Agreement dated May 8, 2008, between us andNuVasive, Inc. for the sale of our Osteocel business unit.  On that same date, the “technology assetsclosing” occurred and we received a payment of $35.0 million in cash under theterms of the Asset Purchase Agreement. The Asset Purchase Agreement also provides for the opportunity for us toreceive up to an additional $50.0 million in milestone payments.  These milestone payments become payablebeginning in the first quarter of 2009, assuming that certain conditions topayment are satisfied.  There can be noassurance that we will successfully complete any or all of the events whichwill trigger any of the milestone payments. Concurrent with the closing of the sale, we entered into a ManufacturingAgreement with NuVasive whereby we will continue to manufacture Osteocel for upto 18-months for the exclusive sale to NuVasive at specified prices.  We understand that NuVasive intends todistribute Osteocel to Blackstone Medical and others in accordance with theterms of certain preexisting agreements.

 

***Cash Flows***

 

Netcash used in operating activities of continuing operations was $11.6 millionfor the three months ended June 30, 2008, primarily reflecting our lossfrom continuing operations of $18.5 million, partially offset by $0.7 millionof non-cash charges and $6.2 million of favorable working capital changes,consisting primarily of increases in accounts payable and accrued expenses.During the second quarter of fiscal 2007, net cash used in operating activitiesof continuing operations was $12.9 million, which was comprised of our lossfrom continuing operations of $12.1 million, netted against $0.8 million ofnon-cash charges and $1.6 million of unfavorable changes in our workingcapital.

 

Netcash provided by operating activities of discontinued operations was $2.1million for the three months ended June 30, 2008, which reflects theincome from discontinued operations of $3.1 million, partially offset byunfavorable changes in working capital of $1.1 million, which is a primarilyincrease in accounts receivable.  Netcash used in operating activities of discontinued operations for the threemonths ended June 30, 2007 was $1.4 million, which is made up of theincome from continuing operations of $1.6 million offset by $3.0 million ofunfavorable working capital changes as we increased both the inventory andaccounts receivable of the Osteocel business unit.

 

Netcash used in investing activities was $0.6 million for the three months ended June 30,2008, consisting of $2.6 million of fixed asset additions, netted against $2.0million of withdrawals from our investments available for sale accounts.  The fixed asset additions are primarilyrelated to the move of our Osteocel manufacturing operations from ourBaltimore, Maryland facility to our Columbia, Maryland facility.  Net cash used in investing activities duringthe second quarter of fiscal 2007 was $6.2 million, including $1.5 million ofcapital expenditures and the net increase in our investments available for sale.  During the three months ended June 30,2007, we invested the proceeds from a $20.0 million private placement of ourcommon stock in investments available for sale.

 

Netcash provided by financing activities was $8.0 million for the three monthsended June 30, 2008, representing the proceeds from the issuance ofconvertible and short-term notes payable. During the second quarter of fiscal 2007, net cash provided by financingactivities was $19.3 million, which primarily resulted from the $20.0 millionprivate placement of common stock.

 

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Netcash used in operating activities of continuing operations was $26.9 millionfor the six months ended June 30, 2008, reflecting our loss fromoperations of $37.6 million, which was partially offset by $2.0 million ofnon-cash charges and $8.8 million of favorable working capital changes,consisting primarily of increases in our accounts payable and accruedexpenses.  Net cash used in operatingactivities of continuing operations for the three months ended June 30,2007 was $22.7 million, reflecting our loss from continuing operations of $22.1million, partially offset by non-cash charges of $1.8 million and netunfavorable working capital changes of $2.3 million.

 

Netcash provided by the operations of discontinued operations was $6.1 million forthe six months ended June 30, 2008, reflecting income from discontinuedoperations of $6.6 million, partially offset by $0.2 million of non-cashcharges and $0.8 million of unfavorable changes in working capital.  Net cash used by discontinued operations forthe six months ended June 30, 2007 was $0.2 million, which is comprised ofincome from discontinued operations of $0.2 million, offset by unfavorablechanges in working capital.

 

Netcash provided by investing activities for the six months ended June 30,2008 was $8.7 million and consisted of proceeds from the sale of investmentsavailable for sale of $12.4 million netted against capital expenditures of $3.7million.  The capital expenditures arerelated primarily to the build-out of our Osteocel manufacturing facilities atour Columbia, Maryland location, and to related equipment purchases.  Net cash provided by investing activities forthe six months ended June 30, 2007 was $3.7 million, which represented$2.3 million of capital expenditures offset by net sale of our investmentsavailable for sale of $6.1 million.

 

Netcash provided by financing activities for the six months ended June 30,2008 was $13.8 million, consisting of borrowings of $10.5 million ofconvertible promissory notes and $5.5 million of short-term promissory notes,netted against payments of $2.2 million on a promissory note we issued in December 2007and payments on our capital leases.  Netcash provided by financing activities for the six months ended June 30,2007 was $19.1 million, primarily reflecting the proceeds of the $20.0 millionprivate placement of our common stock.

 

 ***CapitalResources***

 

Ourfuture capital requirements will depend on many factors, including, but notlimited to:

 

·                       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.

 

Asa result of these and other factors, we will likely need or choose to seekadditional funding prior to our becoming cash flow positive on an operationalbasis.  We would likely seek such fundingthrough public or private financings or some combination of them.  We might also seek funding through additionalcollaborative arrangements if determined to be necessary or appropriate.

 

Additionalfunding may not be available to us on acceptable terms, or at all.  If we obtain capital funding throughcollaborative arrangements, these arrangements could require us to relinquishrights to our technologies or biologic drug candidates.  If we raise capital through the sale ofequity, or securities convertible into equity, dilution to our then existingstockholders would result.  If we raiseadditional 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, servicingthe interest and repayment obligations under these borrowings would divertfunds that would otherwise be available to support research and development,clinical or commercialization activities.

 

Weexpect that our available cash and interest income, including the availabilityunder our line-of-credit and financing commitment, will be sufficient tofinance currently planned activities through at least 2009.  These estimates are based on certainassumptions, which could be negatively impacted by the matters discussed under “RiskFactors” in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K,among other things.

 

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Ifadequate funds are not available, we may be required to delay, reduce the scopeof, or eliminate one or more of our research and development programs, whichmay have a material adverse affect on our business, financial condition andresults of operations.  See “Risk Factors”in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K.

 

**Off-Balance Sheet Arrangements.**

 

Wehave no off-balance sheet financing arrangements and we have not entered intoany transactions involving unconsolidated subsidiaries or special purposeentities.

 

**Item 3.****                                                          ****Quantitative and QualitativeDisclosures About Market Risk**.

 

Dueto the short duration of our investment portfolio and the high quality of ourinvestments, an immediate 10% change in interest rates would not have amaterial effect on the fair market value of our portfolio.  However, our investment portfolio consists ofinvestment grade auction rate certificates which are presently illiquid at parvalue.  Our portfolio managers are presently unable to provide us with anestimate of how long the credit crisis in the auction rate certificate marketwill exist.  During the three monthsended June 30, 2008, we recorded impairment in the fair market value ofour investments available for sale of $632, based upon estimates provided to usby the custodial investment banks.  Thischarge is reflected in the accompanying condensed statement of stockholder’sequity (deficit) as accumulated other comprehensive loss.  Estimating the fair value of investments inauction rate securities requires numerous assumptions and are inherentlysubjective.  There can be no assurance asto when the market for auction rate securities will stabilize.  The fair value of our auction rate securitiescould change significantly based on market conditions and continueduncertainties in the credit markets.  Ifconditions in the credit markets deteriorate further causing additionalauctions to fail, the funds associated with these auction rate certificates maynot be accessible for an undetermined period of time, and we may be required torecord additional unrealized losses in other comprehensive income, or record another than temporary loss as part of net loss.

 

Webelieve that the interest rate risk related to our accounts receivable is notsignificant.  We manage the riskassociated with these accounts through periodic reviews of the carrying valuefor non-collectability and establishment of appropriate allowances inconnection with our internal controls and policies.

 

Wedo not enter into hedging or derivative instrument arrangements.

 

**Item 4.****                                                          ****Controls and Procedures.**

 

***Evaluation of Disclosure Controls andProcedures.*** Anevaluation of the effectiveness of the design and operation of our “disclosurecontrols and procedures” (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934, as amended), as of the end of the periodcovered by this Quarterly Report on Form 10-Q was made under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer.  Acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the control system’s objectives willbe met.  Based upon this evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures (a) are effective to ensure thatinformation required to be disclosed by us in reports filed or submitted underthe Securities Exchange Act of 1934 is timely recorded, processed, summarizedand reported and (b) include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by us in reportsfiled or submitted under the Securities Exchange Act of 1934 is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

***Changes in Internal Control over FinancialReporting.*** Therehave not been any changes in our internal control over financial reporting thatoccurred during the quarter ended June 30, 2008 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

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**PART II- OTHER INFORMATION**

 

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

 

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

 

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

 

There have not been anymaterial changes in the risk factors previously disclosed under the heading “RiskFactors” in Part I - Item 1A of our Annual Report on Form 10-K forthe fiscal year ended December 31, 2007, filed with the United StatesSecurities and Exchange Commission on March 17, 2008, and “Risk Factors”in Part II – Item 1A of our Quarterly Report on Form 10-Q for thefiscal quarter ended March 31, 2008, filed with the United StatesSecurities and Exchange Commission on May 12, 2008.  If any of the risk factors set forth in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2007 or Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,2008 actually occur, our business, financial condition or results of operationscould be materially adversely affected.

 

**Item 2.****                   ****Unregistered Sales of EquitySecurities and Use of Proceeds**.

 

On May 23 2008, we accepted a subscription agreement for the saleof a $2.5 million convertible promissory note to a non-U.S. investor, in aprivate placement intended to qualify under Regulation S and Section 4(2),of the Securities Act of 1933, as amended.  The note was funded on May 29,2008 and bears interest at a rate of four percent (4%) per annum, payable uponmaturity on November 30, 2008. The note is convertible at any time at thesole discretion of the holder into shares of our common stock at the conversionprice of $13.18 per share, and is redeemable by us with thirty days priornotice. The note holder is afforded registration rights in respect of anyshares issued upon conversion.  The netproceeds to us from the offering and sale of the notes have been used tofurther our clinical trial activities and for general corporate purposes.

 

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

 

 None.

 

**Item 4.**                    **Submission of Matters to aVote of Security Holders**.

 

***Annual Meeting***. We held our Annual Meeting of Stockholderson June 4, 2007.  Of the 31,769,836shares of common stock outstanding as of the record date of the Annual Meeting,25,934,971 shares, or 81.6% of the total shares eligible to vote at the AnnualMeeting, were represented in person or by proxy.  Three proposals were submitted to ourstockholders and approved at the Annual Meeting, as follows:

 

*Election of Directors.*  C.Randal Mills and Felix Gutzwiller were elected to serve as members of the boardof directors for a term expiring at our Annual Meeting of Stockholders to beheld in 2011 and until their successors are duly elected and qualified.  The number of votes cast for or withheld fromeach nominee, both in person and by proxy, was as follows:

 
| C. Randal Mills  | 25,768,862 FOR | 166,109  WITHHOLD |
|------------------|----------------|-------------------|
| Felix Gutzwiller | 25,883,060 FOR | 51,911  WITHHOLD  |

 

The term of office of eachPeter Friedli, Jay M. Moyes and Gregory H. Barnhill continued following themeeting.

 

*Approval of Amended and Restated2006 Omnibus Plan.*  The Amended and Restated Plan to increase theaggregate number of shares of common stock available for grants and awards by600,000 shares, and approve other technical changes was approved by thestockholders as follows:

 
| FOR              | 21,043,477 |   |
|------------------|------------|--------|
| AGAINST          | 101,806    |   |
| ABSTAIN          | 5,949      |   |
| BROKER NON-VOTES | 4,783,739  |   |

 

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*Ratify Independent RegisteredPublic Accountants.*  The appointment of Stegman &Company, independent registered public accountants, to act as our independentauditors for the fiscal year ending December 31, 2008 was ratified, asfollows:

 
| FOR     | 25,911,139 |   |
|---------|------------|--------|
| AGAINST | 12,493     |   |
| ABSTAIN | 11,338     |   |

 

***Special Meeting***.  Weheld a Special Meeting of Stockholders on July 24, 2008 to seek approvalof the sale of our Osteocel business to NuVasive, Inc. under the terms andconditions of the Asset Purchase Agreement. Of the 31,770,555 shares of common stock outstanding as of the recorddate of the Special Meeting, 20,287,831, or 63.4% of the total shares eligibleto vote, were represented in person or by proxy.  One proposal was submitted to ourstockholders and approved at the Special Meeting as follows:

 

*Approval of the Asset PurchaseAgreement and the Transactions Contemplated Thereby. *The Asset Purchase Agreement and the transactions contemplated therebywere 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                |       | Amended and Restated 2006 Omnibus Plan of the Registrant, dated  June 4, 2008.                                                                                                                                                                                                                                                                                          |
|                |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.2                |       | Asset Purchase Agreement, dated May 8, 2008, by and between the  Registrant and NuVasive, Inc. (Incorporated herein by reference to  Exhibit 10.01 to the Current Report on Form 8-K filed by the  Registrant wit the SEC on May 12, 2008.)                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.3                |       | Form of Voting Agreement, dated May 8, 2008, by and among  each of Peter Friedli, Venturetec, Inc., U.S. Venture 05, Inc.,  Joyce, Ltd. and C. Randal Mills, Ph.D., and NuVasive, Inc. (Incorporated  herein by reference to Exhibit 10.02 to the Current Report on  Form 8-K filed by the Registrant with the SEC on May 12, 2008.) |
|                |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.4                |       | Form of Subscription Agreements, dated June 12, 2008 and  June 30, 2008, respectively, by and between the Registrant and certain  non-U.S. purchasers in connection with the issuance and sale of Promissory  Notes in the aggregate principal amount of $5.5 million.                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5                |       | Form of Promissory Notes of the Registrant, dated June 12,  2008 and June 30, 2008, issued to certain non-U.S. purchasers in the  aggregate principal amount of $5.5 million.                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 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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**SIGNATURES**

 

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

 
|                       | **Osiris Therapeutics, Inc.**                       |
|----------------------------|----------------------------------------------------------|
|                       |                                                     |
| Date: August 11, 2008 | /s/ RICHARD W. HUNT                                      |
|                       | Richard W. Hunt                                          |
|                       | Chief Financial Officer (Principal Financial Officer)    |
|                       |                                                     |
| Date: August 11, 2008 | /s/ PHILIP R. JACOBY, JR.                                |
|                       | Philip R. Jacoby, Jr.                               |
|                       | Vice President of Finance (Principal Accounting Officer) |

 

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