**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

 

 

| **x**                                                                                                                                                                                                                                                                        | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                   | ** **                                                                                    |
| **For the quarterly period ended September 30, 2007**                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                         |                                                                                          |
| **o**                                                                                                                                                                                                                                                                        | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                   | ** **                                                                                    |
| **For the transition period from                      to                    ** |

 

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

 

**OSIRISTHERAPEUTICS, INC.**

(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**

(Addressof 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 mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  x    No  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer.  See definitionof “accelerated filer and large accelerate filer” in Rule 12b-2 of the ExchangeAct). (Check one):

 

Large accelerated filer o            Accelerated filer  o            Non-accelerated filer x

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock as of the latest practicable date.

 

| **Class**                                 | ** ** | **Outstanding at November 13, 2007** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|
| Common  Stock, par value $0.001 per share |       | 29,229,788                                               |       |

 

 

----

 

**OSIRISTHERAPEUTICS, INC.**

**INDEX**

 
| ** **                               | ** **                                                                                          | ** ** |
|------------------------------------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                               | ** **                                                                                          | ** ** |
| **PART I —  FINANCIAL INFORMATION** | 3                                                                                                   |
| ** **                               | ** **                                                                                          | ** ** |
| Item 1.                                  | Financial Statements —  Unaudited.                                                             | 3          |
|                                     | Condensed Balance Sheets —  September 30, 2007 and December 31, 2006                           | 3          |
|                                     | Condensed  Statements of Operations — three and nine months ended September 30, 2007 and  2006 | 4          |
|                                     | Condensed  Statement of Stockholders’ Equity — nine months ended September 30, 2007       | 5          |
|                                     | Condensed Statements  of Cash Flows — nine months ended September 30, 2007 and 2006            | 6          |
|                                     | Notes  to Condensed Financial Statements                                                            | 7          |
|                                     |                                                                                                |       |
| Item  2.                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.        | 11         |
|                                     |                                                                                                |       |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk.                                        | 17         |
|                                     |                                                                                                |       |
| Item 4.                                  | Controls and  Procedures.                                                                           | 17         |
|                                     |                                                                                                |       |
| **PART  II — OTHER INFORMATION**    | 18                                                                                                  |
|                                     |                                                                                                |       |
| Item 1.                                  | Legal Proceedings.                                                                                  | 18         |
| Item 1A.                            | Risk Factors.                                                                                       | 18         |
| Item  2.                                 | Unregistered  Sales of Equity Securities and Use of Proceeds.                                       | 18         |
| Item  3.                                 | Defaults Upon  Senior Securities.                                                                   | 19         |
| Item  4.                                 | Submission of  Matters to a Vote of Security Holders.                                               | 19         |
| Item 5.                                  | Other Information.                                                                                  | 19         |
| Item 6.                                  | Exhibits.                                                                                           | 19         |
|                                     |                                                                                                |       |
| Signature                                |                                                                                                | 20         |
|                                     |                                                                                                |       |
| Exhibit Index                            |                                                                                                |       |

 

2

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**PART I — FINANCIAL INFORMATION**

 

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

 

**OSIRIS THERAPEUTICS, INC.**

**Condensed Balance Sheets**

**Amounts in thousands**

 
| ** **                                                                                                     | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                     | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                     |       |                         |       |                        |       |
| Current assets:                                                                                                |       |                         |       |                        |       |
| Cash                                                                                                           |       | $                            | 584        |                        | $          | 714 |   |
| Short-term investments                                                                                         |       | 21,756                       |       | 38,467                      |       |
| Accounts receivable                                                                                            |       | 1,759                        |       | 1,596                       |       |
| Inventory and other current assets                                                                             |       | 3,444                        |       | 2,858                       |       |
| Total current assets                                                                                           |       | 27,543                       |       | 43,635                      |       |
|                                                                                                           |       |                         |       |                        |       |
| Property and equipment, net                                                                                    |       | 6,784                        |       | 3,942                       |       |
| Restricted cash                                                                                                |       | 280                          |       | 297                         |       |
| Deferred financing costs, net                                                                                  |       | 385                          |       | 567                         |       |
| Other assets                                                                                                   |       | 333                          |       | 727                         |       |
| Total assets                                                                                                   |       | $                            | 35,325     |                        | $          | 49,168 |   |
|                                                                                                           |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                 |       |                         |       |                        |       |
| Current liabilities:                                                                                           |       |                         |       |                        |       |
| Accounts payable and accrued expenses                                                                          |       | $                            | 6,904      |                        | $          | 8,339 |   |
| Note payable, current portion                                                                                  |       | —                       |       | 49                          |       |
| Capital lease obligations, current portion                                                                     |       | 1,178                        |       | 1,129                       |       |
| Deferred revenue, current portion                                                                              |       | 635                          |       | 952                         |       |
| Total current liabilities                                                                                      |       | 8,717                        |       | 10,469                      |       |
|                                                                                                           |       |                         |       |                        |       |
| Note payable, net of current portion                                                                           |       | 25,000                       |       | 25,000                      |       |
| Capital lease obligations, net of current portion                                                              |       | 11                           |       | 895                         |       |
| Deferred revenue, net of current portion                                                                       |       | —                       |       | 397                         |       |
| Long-term interest payable and other liabilities                                                               |       | 1,420                        |       | 1,120                       |       |
| Total liabilities                                                                                              |       | 35,148                       |       | 37,  881                    |       |
|                                                                                                           |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                     |       |                         |       |                        |       |
| Common stock, $.001 par value, 90,000 shares authorized 29,230 and  27,321 shares outstanding in 2007 and 2006 |       | 29                           |       | 27                          |       |
| Additional paid-in-capital                                                                                     |       | 220,000                      |       | 198,763                     |       |
| Accumulated deficit                                                                                            |       | (219,852                     | )          | (187,503                    | )          |
| Total stockholders’ equity                                                                                |       | 177                          |       | 11,287                      |       |
| Total liabilities and stockholders’ equity                                                                |       | $                            | 35,325     |                        | $          | 49,168 |   |

 

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

 

3

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**OSIRISTHERAPEUTICS, INC.**

**CondensedStatements of Operations**

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

 

 
| ** **                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Product sales                                              |       | $                                                    | 4,003      |                                                | $          | 2,539 |   | $ | 9,255 |   | $ | 5,333 |   |
| Cost of goods sold                                         |       | 1,826                                                |       | 1,113                                               |       | 4,230 |   | 2,364 |   |
| Gross profit                                               |       | 2,177                                                |       | 1,426                                               |       | 5,025 |   | 2,969 |   |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Revenue from collaborative research licenses and royalties |       | 294                                                  |       | 302                                                 |       | 868 |   | 895 |   |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Operating expenses:                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Research and development                                   |       | 10,842                                               |       | 9,242                                               |       | 32,455 |   | 24,532 |   |
| General and administrative                                 |       | 1,689                                                |       | 5,300                                               |       | 4,696 |   | 7,647 |   |
| Total operating expenses                                   |       | 12,531                                               |       | 14,542                                              |       | 37,151 |   | 32,179 |   |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from operations                                       |       | (10,060                                              | )          | (12,814                                             | )          | (31,258 | ) | (28,315 | ) |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Interest expense, net                                      |       | (330                                                 | )          | (2,751                                              | )          | (1,091 | ) | (3,976 | ) |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                                   |       | $                                                    | (10,390    | )                                                   | $          | (15,565 | ) | $ | (32,349 | ) | $ | (32,291 | ) |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and diluted net loss per share                       |       | $                                                    | (0.36      | )                                                   | $          | (0.75 | ) | $ | (1.15 | ) | $ | (2.47 | ) |
|                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average common shares (basic and diluted)         |       | 29,230                                               |       | 20,769                                              |       | 28,234 |   | 13,063 |   |

 

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

 

4

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**OSIRIS THERAPEUTICS, INC.**

**Condensed Statement of Stockholders’ Equity**

**For the nine months ended September 30, 2007(Unaudited)Amounts in thousands, except for share and per share data**

 
| ** **                                                                                    | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated** | ** ** | **Total  Stockholders’** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|-------------------------------|------------|
| ** **                                                                                    | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**                   | ** ** | **Equity** | ** ** |
| **Balance at January 1, 2007**                                                                |       | 27,321,319            |       | $                       | 27         |            | $          | 198,763                       |       | $ | (187,503 | ) | $ | 11,287 |   |
|                                                                                          |       |                  |       |                    |       |            |       |                          |       |   |   |
| Issuance of common stock through private placement, net of offering  costs ($11.38 per share) |       | 1,757,469             |       | 2                       |       | 19,948          |       | —                        |       | 19,950 |   |
|                                                                                          |       |                  |       |                    |       |            |       |                          |       |   |   |
| Exercise of options to purchase common stock ($0.40 - $6.84 per  share)                       |       | 138,500               |       | —                  |       | 59              |       | —                        |       | 59 |   |
|                                                                                          |       |                  |       |                    |       |            |       |                          |       |   |   |
| Issuance of common stock for services rendered by directors ($23.62  per share)               |       | 12,500                |       | —                  |       | 295             |       | —                        |       | 295 |   |
|                                                                                          |       |                  |       |                    |       |            |       |                          |       |   |   |
| Share-based payment — employee compensation                                              |       | —                |       | —                  |       | 935             |       | —                        |       | 935 |   |
|                                                                                          |       |                  |       |                    |       |            |       |                          |       |   |   |
| Net loss                                                                                      |       | —                |       | —                  |       | —          |       | (32,349                       | )          | (32,349 | ) |
|                                                                                          |       |                  |       |                    |       |            |       |                          |       |   |   |
| **Balance at September 30, 2007**                                                        |       | 29,229,788            |       | $                       | 29         |            | $          | 220,000                       |       | $ | (219,852 | ) | $ | 177 |   |

 

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

 

5

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**OSIRIS THERAPEUTICS, INC.**

**Condensed Statements of Cash Flows**

**(Unaudited)Amounts in thousands**

 
| ** **                                                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                                   |       | **2007**                                                | ** ** | **2006** |   |
|                                                                   |       |                                                    |       |   |   |
| **Cash flows from operations:**                                        |       |                                                    |       |   |   |
| Net loss                                                               |       | $                                                       | (32,349    | ) | $ | (32,291 | ) |
| **Adjustments to reconcile net loss to net cash used  in operations:** |       |                                                    |       |   |   |
| Depreciation and amortization                                          |       | 1,341                                                   |       | 1,139 |   |
| Non cash share-based payments                                          |       | 1,230                                                   |       | 5,887 |   |
| Non cash interest expense                                              |       | 182                                                     |       | 3,961 |   |
| **Changes in operating assets and liabilities:**                       |       |                                                    |       |   |   |
| Accounts receivable                                                    |       | (163                                                    | )          | (39 | ) |
| Inventory and other current assets                                     |       | (586                                                    | )          | (1,579 | ) |
| Other assets                                                           |       | 393                                                     |       | (78 | ) |
| Accounts payable and accrued expenses                                  |       | (1,366                                                  | )          | 2,956 |   |
| Deferred revenue                                                       |       | (714                                                    | )          | (714 | ) |
| Long-term interest payable and other liabilities                       |       | 299                                                     |       | (1,996 | ) |
| Net cash used in operations                                            |       | (31,733                                                 | )          | (22,754 | ) |
|                                                                   |       |                                                    |       |   |   |
| **Cash flows from investing activities:**                              |       |                                                    |       |   |   |
| Purchases of property and equipment                                    |       | (4,184                                                  | )          | (933 | ) |
| Proceeds from redemption of short-term investments                     |       | 35,787                                                  |       | 26,586 |   |
| Purchases of short-term investments                                    |       | (18,730                                                 | )          | (35,805 | ) |
| Net cash provided by (used in) investing activities                    |       | 12,873                                                  |       | (10,152 | ) |
|                                                                   |       |                                                    |       |   |   |
| **Cash flows from financing activities:**                              |       |                                                    |       |   |   |
| Principal payments on capital lease obligations and notes payable      |       | (896                                                    | )          | (808 | ) |
| Restricted cash                                                        |       | 17                                                      |       | (113 | ) |
| Proceeds from the issuance of common stock, net of offering costs      |       | 20,009                                                  |       | 34,795 |   |
| Payment of debt financing fees                                         |       | (400                                                    | )          | — |   |
| Net cash provided by financing activities                              |       | 18,730                                                  |       | 33,874 |   |
|                                                                   |       |                                                    |       |   |   |
| Net (decrease) increase in cash                                        |       | (130                                                    | )          | 968 |   |
| Cash at beginning of period                                            |       | 714                                                     |       | 597 |   |
|                                                                   |       |                                                    |       |   |   |
| **Cash at end of period:**                                             |       | $                                                       | 584        |   | $ | 1,565 |   |

 

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

 

6

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**OSIRIS THERAPEUTICS, INC.**

**NOTES TOCONDENSED FINANCIAL STATEMENTS**

**Amounts in thousands, except for share andper share data**

 

**1.              Basis of Presentation**

 

The accompanying unauditedcondensed financial statements of Osiris Therapeutics, Inc. (the “Company”) havebeen prepared in accordance with generally accepted accounting principles inthe United States and the rules and regulations of the Securities and ExchangeCommission (the “SEC”), for interim financial information.  Accordingly,they do not include all the information and footnotes required by generallyaccepted accounting principles for complete financial statements and should beread in conjunction with the Company’s Annual Report on Form 10-K for the yearended December 31, 2006.  The interim financial statements are unaudited,but in the opinion of management all adjustments, consisting only of normalrecurring accruals, considered necessary for a fair statement of the results ofthese interim periods have been included.  The results of the Company’soperations for any interim period are not necessarily indicative of the resultsthat may be expected for any other interim period or for a full fiscal year.

 

**2.              Significant Accounting Policiesand Recent Accounting Pronouncements**

 

***Use of Estimates***

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes. Due tothe inherent uncertainty involved in making those assumptions, actual resultscould differ from those estimates. We believe that the most significantestimates that affect our financial statements are those that relate to revenuerecognition, deferred tax assets, and share-based compensation.

 

***Revenue Recognition***

 

Our revenue recognitionpolicies are in accordance with the SEC’s Staff Accounting BulletinNo. 101, *Revenue Recognition inFinancial Statements*, as amended by SEC Staff Accounting Bulletin No. 104,*Revenue Recognition*.

 

In July 2005, welaunched Osteocel, our first commercial product. We recognize revenue onOsteocel sales when legal title to the product has passed to the customer,which is generally when the product is shipped from our Baltimore, MDfacilities. We have agreements with our customers that specify the terms ofsale, including price.

 

***Cost of Goods Sold***

 

Costs of goods sold consistprimarily of the costs to obtain the tissue and other chemicals and supplies,plus labor and allocated overhead costs and the costs of operating theclean-room facilities related to the production of Osteocel.

 

***Loss per Common Share***

 

Basic loss per common shareis calculated by dividing net loss by the weighted average number of commonshares outstanding during the period. Diluted loss per common share adjustsbasic loss per share for the potentially dilutive effects of shares issuableunder our stock option plan, using the treasury stock method. Common equivalentshares from the conversion of convertible debt and the exercise of stockoptions and warrants are excluded from the computation of diluted loss pershare as their effect is antidilutive.

 

***Stock-Based Compensation Plans***

 

In 1994, we adopted theAmended and Restated 1994 Stock Incentive Plan (the 1994 Plan) under which875,000 shares of common stock have been reserved for issuance upon theexercise of options or other equity grants that we issue from time totime.  In 2006, we adopted the 2006 Omnibus Plan, under which we reserved850,000 shares of common stock for issuance upon the exercise of stockoptions or other equity grants.  We stopped granting options under the1994 Plan upon the completion of our initial public offering in August 2006.

 

7

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A summary of the combinedactivity under both of our stock-based compensation plans as of September 30,2007 and changes during the nine months then ended is presented below.

 
| ** **                              | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price Per Share  at Grant Date** | ** ** | **Weighted Average  Remaining Term  (in Years)** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding  at December 31, 2006  |       | 695,915                    |       | $                                                                                           |  2.05 |                                                            | 8.3        |                                | $          |  16,149 |   |
| Granted                                 |       | 327,500                    |       | 19.27                                                                                       |       |                                                            |       |                                |       |
| Exercised                               |       | (138,500                   | )          | 0.42                                                                                        |       |                                                            |       | 2,145                               |       |
| Forfeited  or expired                   |       | (24,381                    | )          | 3.93                                                                                        |       |                                                            |       |                                |       |
| Outstanding  at September 30, 2007 |       | 860,534                    |       | 8.77                                                                                        |       | 8.5                                                             |       | 3,550                               |       |
|                                    |       |                       |       |                                                                                        |       |                                                            |       |                                |       |
| Exercisable  at September 30, 2007 |       | 328,145                    |       | 1.24                                                                                        |       | 7.5                                                             |       | 3,821                               |       |
|                                         |            |                            |            |                                                                                             |            |                                                                 |            |                                     |            |  |  |

 

The weighted average grantdate fair value of options granted during the nine months endedSeptember 30, 2007 was $13.07 per share. We received a total of $59in cash from the exercise of options during the nine months ended September 30,2007.

 

Also during the nine monthsended September 30, 2007, we granted 12,500 unrestricted shares of common stockto members of our Board of Directors under our 2006 Omnibus Plan and recognized$295 in share-based expense.  As of September 30, 2007, 380,760 shares ofcommon stock remain available for future grants under our 2006 Omnibus Plan.

 

Share-based compensation,(excluding director compensation) included in the statements of operations forthe three and nine months ended September 30, 2007 and 2006 was: 

 
| ** **                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                  | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Biologic  drug candidates   |       | $                                                    | 252        |                                                | $          | 83 |   | $ | 582 |   | $ | 296 |   |
| Biologic  tissue product    |       | 15                                                   |       | —                                              |       | 61 |   | — |   |
| General  and administrative |       | 114                                                  |       | 832                                                 |       | 292 |   | 1,030 |   |
| Total                       |       | $                                                    | 381        |                                                | $          | 915 |   | $ | 935 |   | $ | 1,326 |   |

 

As of September 30, 2007,there was approximately $4.5 million of total unrecognized share-basedcompensation cost related to options granted under our plans that will berecognized over a weighted-average period of approximately 3.5-years.

 

***Supplemental Cash Flow Information***

 
| ** **                                                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| **Supplemental disclosure of cash flows information:**                     |       |                                                |       |   |   |
| Cash  paid for interest                                                    |       | $                                                   | 1,219      |   | $ | 760 |   |
| Cash  paid for taxes                                                       |       | —                                              |       | — |   |
|                                                                       |       |                                                |       |   |   |
| **Supplemental schedule of non-cash investing and financing  activities:** |       | ** **                                          | ** ** | ** ** | ** ** |
| Common  stock issued to directors for services rendered                    |       | 295                                                 |       | 198 |   |
|                                                                            |            |                                                     |            |  |  |  |  |

 

***Significant New Accounting Pronouncements***

 

In September 2006, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 157, *Fair Value Measurements* (“SFAS No.157”).  Thisstatement provides a single definition of fair value, a framework for measuringfair value, and expanded disclosures concerning fair value.  Previously,different definitions of fair value were contained in various accountingpronouncements creating inconsistencies in measurement and disclosures. SFAS No. 157 applies under those previously issued pronouncements thatprescribe fair value as the relevant measure of value, except SFAS No. 123(R)and related interpretations and pronouncements that require or permit measurementsimilar to fair value but are not intended to measure fair value.  Thispronouncement is effective for fiscal years beginning after November 15,2007.  The Company is evaluating the impact of this new standard, butcurrently believes that the adoption of SFAS No. 157 will not have a materialimpact on its financial position, results of operations, or cash flows.

 

8

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In February 2007, theFASB issued Statement No. 159, “*The Fair Value Option for Financial Assets andFinancial Liabilities — Including an amendment of FASB Statement No. 115*(“SFAS 159”). SFAS 159 provides companies with an option to report selectedfinancial assets and liabilities at fair value. SFAS 159’s objectives are toreduce both complexity in accounting for financial instruments and thevolatility in earnings caused by measuring related assets and liabilitiesdifferently. SFAS 159 is effective as of the beginning of an entity’s firstfiscal year beginning after November 15, 2007. The Company is currentlyevaluating the potential impact, if any, that the adoption of SFAS159 will haveon its condensed consolidated financial statements.

 

In June 2007, the FASBratified a consensus opinion reached by the Emerging Issues Task Force(EITF) on EITF Issue 07-3, *Accounting for Nonrefundable Advance Payments forGoods or Services Received for Use in Future Research and DevelopmentActivities* (“EITF Issue 07-3”). The guidance in EITF Issue 07-3requires the Company to defer and capitalize nonrefundable advance paymentsmade for goods or services to be used in research and development activitiesuntil the goods have been delivered or the related services have beenperformed. If the goods are no longer expected to be delivered nor the servicesexpected to be performed, the Company would be required to expense the relatedcapitalized advance payments. The consensus in EITF Issue 07-3 is effective forfiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2007 and is to be applied prospectively to new contractsentered into on or after December 15, 2007. Early adoption is notpermitted. Retrospective application of EITF Issue 07-3 is also not permitted.The Company intends to adopt EITF Issue 07-3 effective January 1, 2008. Theimpact of applying this consensus will depend on the terms of the Company’sfuture research and development contractual arrangements entered into on orafter December 15, 2007.

 

**3.              Segment Reporting**

 

In 2007, we began to manageour business in two reportable operating segments: the Biologic Drug Candidatessegment and the Biologic Tissue Product segment.  Our Biologic DrugCandidates segment focuses on developing and marketing products to treatmedical conditions in the inflammatory, orthopedic and cardiovascularareas.  Its operations have focused on clinical trials.  Our BiologicDrug Candidates segment does not presently have any products approved for saleand its revenues consist of license fees and royalties from collaborativeresearch agreements.

 

Our Biologic Tissue Productsegment includes the manufacture and sale of Osteocel, which we launched inJuly 2005 and is currently being used by orthopedic surgeons for focal bonerepair.

 

We evaluate the performanceof our Biologic Tissue Product segment based upon gross margin and operatingincome before net interest expense, depreciation, and corporate general andadministrative expenses, which we refer to as segment profit or loss.  Wehave presented estimated 2006 segment results through the gross profit resultto compare to our 2007 presentation in the table below.  However, becauseour Biologic Tissue Product segment was not managed as a separate segmentduring 2006 we are unable to determine the other operating expenses that mayhave been attributable to this segment in 2006.

 

In general, our totalassets, including long-lived assets such as property and equipment, and ourcapital expenditures are not specifically allocated to any particular operatingsegment.  Accordingly, capital expenditures and total asset information byreportable segment is not presented.  The reportable segments use the sameaccounting policies as those used by the Company.  There are nosignificant inter-segment sales or transfers.

 

Substantially all of ourrevenues and assets are attributed to and are received from entities located inthe United States.  During the three and nine months ended September 30,2007 and 2006, we sold product produced in our Biologic Tissue Product segmentprimarily to two customers, both of which represent greater than ten percent ofour revenues.

 

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The table below sets forththe revenues, gross margin and segment profit (loss) for the three and ninemonths ended September 30, 2007, and the revenues and gross margin for thethree and nine months ended September 30, 2006.

 
| ** **                                | ** ** | **Biologic  Drug** | ** ** | **Biologic  Tissue** | ** ** | ** **    | ** ** | ** ** | ** **   |
|-------------------------------------------|------------|--------------------|------------|----------------------|------------|---------------|------------|------------|--------------|
| ** **                                | ** ** | **Candidates**     | ** ** | **Product**          | ** ** | **Corporate** | ** ** | **Total**  | ** **   |
| **Three Months Ended September 30, 2007** | ** ** | ** **         | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** **   |
| Revenues                                  |       | $                  |  294  |                 | $          | 4,003         |       | $          |  — |   | $ | 4,297 |   |
| Gross  margin                             |       | —             |       | 2,177                |       |          |       | 2,177      |         |
| Segment  profit (loss)                    |       | (10,151            | )          | 1,781                |       | (1,690        | )          | (10,060    | )            |
|                                      |       |               |       |                 |       |          |       |       |         |
| **Nine Months Ended September 30, 2007**  | ** ** | ** **         | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** **   |
| Revenues                                  |       | $                  |  868  |                 | $          | 9,255         |       | $          |  — |   | $ | 10,123 |   |
| Gross  margin                             |       | —             |       | 5,025                |       |          |       | 5,025      |         |
| Segment  profit (loss)                    |       | (28,511            | )          | 1,950                |       | (4,697        | )          | (31,258    | )            |
|                                      |       |               |       |                 |       |          |       |       |         |
| **Three Months Ended September 30, 2006** | ** ** | ** **         | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** **   |
| Revenues                                  |       | $                  |  302  |                 | $          | 2,539         |       | $          |  — |   | $ | 2,841 |   |
| Gross  margin                             |       | —             |       | 1,426                |       |          |       | 1,426      |         |
|                                      |       |               |       |                 |       |          |       |       |         |
| **Nine Months Ended September 30, 2006**  | ** ** | ** **         | ** ** | ** **           | ** ** | ** **    | ** ** | ** ** | ** **   |
| Revenues                                  |       | $                  |  895  |                 | $          | 5,333         |       | $          |  — |   | $ | 6,228 |   |
| Gross  margin                             |       | —             |       | 2,969                |       |          |       | 2,969      |         |

 

We reported a loss in ourBiologic Tissue Product segment for the quarter ending March 31, 2007 which wasprimarily attributable to costs associated with the expansion of our Osteocelmanufacturing facility, as we experienced failed production qualification runswhile expanding our capacity. The production issues were subsequently resolvedin late March 2007, and the expanded facility is currently producing product inline with our expectations.

 

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

 

**Forward-Looking Information**

 

This report includes “forward-lookingstatements” within the meaning of Section 21E of the Securities ExchangeAct of 1934, or the Exchange Act. Forward-looking statements include statementsconcerning our plans, objectives, goals, strategies, future events, futurerevenues or performance, capital expenditures, compensation arrangements,financing needs, plans or intentions relating to acquisitions, business trendsand other information that is not historical information and, in particular, mayappear under the headings “Risk Factors” in our Annual Report 10-K underPart I—Item 1A, “Part II—Item 7. Management’s Discussion and Analysisof Financial Condition and Results of Operations” and the other documents wefile with the Securities and Exchange Commission, or SEC, including, amongothers, our quarterly reports on Form 10-Q and any amendments thereto.When used in this Quarterly Report, the words *estimates,expects, anticipates, projects, plans, intends, believes, forecasts*and variations of such words or similar expressions are intended to identifyforward-looking statements. Examples of forward-looking statements include, butare not limited to, statements regarding the following: our product developmentefforts; our clinical trials and anticipated regulatory requirements; thesuccess of our product candidates in development; status of the regulatoryprocess for our biologic drug candidates; implementation of our corporatestrategy; our financial performance; our product research and developmentactivities and projected expenditures, including our anticipated timeline andclinical strategy for mesenchymal stemcells and biologic drugcandidates; our cash needs; patents and proprietary rights; ability of ourpotential products to treat disease; our plans for sales and marketing; ourplans regarding facilities; types of regulatory frameworks we expect will beapplicable to our potential products; and results of our scientific research.All forward-looking statements, including, without limitation, management’sexamination of historical operating trends, are based upon our currentexpectations and various assumptions. Our expectations, beliefs and projectionsare expressed in good faith and we believe there is a reasonable basis forthem. However, there can be no assurance that management’s expectations,beliefs and projections will result or be achieved.

 

You should read thefollowing management’s discussion and analysis of our financial condition andresults of operations in conjunction with our audited Financial Statements andrelated notes thereto and other disclosures included as part of our AnnualReport on Form 10-K for the year ended December 31, 2006, and ourunaudited Condensed Financial Statements for the three and nine months ended September30, 2007 and other disclosures included in this Quarterly Report on Form 10-Q.Our Condensed Financial Statements have been prepared in accordance with U.S.generally accepted accounting principles and are presented in U.S. dollars.

 

There are a number of risksand uncertainties that could cause our actual results to differ materially fromthe forward-looking statements contained in this report. Some of the importantfactors that could cause our actual results to differ materially from theforward-looking statements we make in this report are set forth in this reportor in our Annual Report on Form 10-K for the fiscal year ended December 31,2006 under Part I — Item 1A “Risk Factors.” There may be other factors that maycause our actual results to differ materially from the forward-lookingstatements.

 

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

 

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

 

**Introduction and Overview**

 

The following is adiscussion and analysis of our financial condition and results of operationsfor the three and nine month periods ended September 30, 2007 and 2006. You should read this discussion together with the accompanying unauditedcondensed financial statements and notes and with our Annual Report on Form10-K for the year ended December 31, 2006.  Historical results and anydiscussion of prospective results may not indicate our futureperformance.  See “Forward Looking Information.”

 

We are a leading stem celltherapeutic company focused on developing and marketing products to treatmedical conditions in the inflammatory, orthopedic and cardiovascularareas.  We currently market and sell Osteocel for regeneratingbone in orthopedic indications. Prochymal is in Phase III clinical trials for both Graft verses HostDisease and Crohn’s disease and is the only stem cell therapeutic currentlydesignated by the FDA as both an Orphan Drug and Fast Track product.  We have also partnered with GenzymeCorporation to develop Prochymal as a medical countermeasure to nuclearterrorism and other radiological emergencies. Our pipeline of internally developed biologic drug candidates underevaluation also includes Chondrogen for arthritis in the knee, and Provacel,for repairing heart tissue following a heart attack. We are a fully integratedcompany, having developed capabilities in research, development, manufacturing,marketing and distribution of stem cell products.  We have developed extensive intellectualproperty portfolio to protect our technology in the United States and a numberof foreign countries including 47 U.S. and 211 foreign patents owned or licensed. Beginning in the first quarter of 2007, webegan to manage our business in two operating segments.  Our reportableoperating segments that are managed separately consist of our Biologic DrugCandidates segment and our Biologic Tissue Product segment.

 

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In ourBiologic Drug Candidates segment, we currently have seven clinical trialsongoing.  We are currently enrollingpatients in a Phase III clinical trial for Prochymal, our leading biologic drugcandidate, for the treatment of steroid refractory Graft verses Host Disease,or GvHD, a life threatening complication of bone marrow transplantation.  We recently received clearance to commence aPhase III clinical trial for Prochymal for the treatment of acute GvHD and areenrolling patients in a Phase III trial using Prrochymal to treat Crohn’sDisease.  We also received FDA approvalof a new IND for diabetes and clearance to conduct a Phase II trial evaluatingProchymal for the treatment of type 1 diabetes. In addition, we have two other clinical stage biologic drug candidates;Chrondrogen for arthritis in the knee, and Provacel for repairing heart tissuefollowing a heart attack.  We havedeveloped stem cell capabilities in research and development, manufacturing,marketing and distribution.  Wemanufacture clinical batches of our biologic drug candidates and contract withindependent pharmaceutical companies to manufacture additional batches.

 

Our Biologic Tissue Productsegment  produces and markets Osteocel, which was launched in July 2005 for regenerating bone in orthopedic indications.  Duringthe first quarter of 2007, we expanded our Osteocel manufacturing facility andexperienced failed production qualification runs.  The production issueswere subsequently resolved in late March 2007, and the expanded facility iscurrently producing product in line with our expectations. We manufactureOsteocel in our Baltimore, MD clean-room facilities. We, together withAlloSource, distribute Osteocel in orthopedic indications and we jointlydistribute Osteocel with Blackstone Medical, Inc., a division of OrthofixInternational, N.V., for spinal procedures and orthopedic indications.

 

We have incurred annualoperating losses since inception and expect to incur substantial operatinglosses in the future in connection with the development of our core products.As of September 30, 2007, we had an accumulated deficit of $220 million.

 

**Financial Operations Overview**

 

*Revenue*

 

Osteocel is our onlycommercial product. Sales of Osteocel generated revenue of approximately $4.0million and $9.3 million for the three and nine months ended September 30,2007, respectively.

 

Other than Osteocel, we haveno commercial products for sale. A substantial portion of our revenue in thefuture will be dependent on the approval and sale of our biologic drugcandidates. Our revenue may vary substantially from quarter to quarter and fromyear to year. We believe that period-to-period comparisons of our results ofoperations are not meaningful and should not be relied upon as indicative ofour future performance.

 

*Cost of Goods Sold*

 

Our cost of goods soldrelate to direct costs of producing Osteocel. Cost of goods sold consistprimarily of the costs of obtaining tissue and other chemicals and supplies,direct labor and allocated costs of our facilities and overhead.

 

*Research and Development Costs*

 

Our research and developmentcosts consist of expenses incurred in identifying, developing and testingbiologic drug candidates and our biologic tissue product. These expensesconsist primarily of salaries and related expenses for personnel, fees paid toprofessional service providers for independent monitoring and analysis of ourclinical trials, costs of contract research and manufacturing, costs offacilities, and the costs of manufacturing clinical batches of biologic drugcandidates, quality control supplies and material to expand biologic drugcandidates.

 

Consistent with our focus onthe development of biologic drug candidates with potential uses in multipleindications, many of our costs are not attributable to a specificallyidentified project. We use our employee and infrastructure resources acrossseveral projects. Accordingly, we do not account for internal research anddevelopment costs on a project-by-project basis. As a result, we cannot stateprecisely the total costs incurred for each of our clinical and preclinicalprojects on a project-by-project basis. From inception in December 1992 throughSeptember 30, 2007, we incurred aggregate research and development costs ofapproximately $216 million. We expect our research and development expenses toincrease substantially in the future, as we expand our clinical trial activity,as our biologic drug candidates advance through the development cycle and as weinvest in additional product opportunities and research programs. Clinicaltrials and preclinical studies are time-consuming and expensive. Ourexpenditures on current and future preclinical and clinical developmentprograms are subject to many uncertainties. We test our products in severalpreclinical studies, and we then conduct clinical trials for those biologicdrug candidates that we determine to be the most promising. As we obtainresults from clinical trials, we may elect to discontinue or delay trials forsome biologic drug candidates in order to focus our resources on more promisingbiologic drug candidates. Completion of clinical trials may take several yearsor more, but the length of time generally varies substantially according to thetype, size of trial and intended use of a biologic drug candidate. The cost ofclinical trials may vary significantly over the life of a project as a resultof a variety of factors, including:

 

•                     the number of patients who participate in 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.

 

 

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

 

*General and Administrative Expenses*

 

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

 

*InterestExpense,Net*

 

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

 

*Income Taxes*

 

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

 

**Critical Accounting Policies**

 

There have been no materialchanges in our critical accounting policies, estimates and judgments during thethree and nine months ended September 30, 2007 compared to the disclosures inPart II, Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2006, other than as disclosed herein.

 

**Results of Operations**

 

***Comparison of Quarters endedSeptember 30, 2007 and 2006***

 

*Revenue*

 

Total revenues increased 54%to $4.3 million for the three months ended September 30, 2007, compared to$2.8 million in the corresponding period in 2006. Our revenues for thethree months ended September 30, 2007 resulted primarily from $4.0 milliongenerated from the sale of Osteocel and the recognition of $0.3 million inlicensing fees and royalties. In the three months ended September 30, 2006, werecognized $2.5 million from the sale of Osteocel and $0.3 million inlicense fees and royalties.  The increase in Osteocel revenues resultedprimarily from higher sales volumes, and to a lesser extent, increases inprices.

 

*Cost of Goods Sold*

 

Cost of goods sold were$1.8 million for the three months ended September 30, 2007 compared to$1.1 million in the corresponding period in fiscal 2006. The cost of goods soldassociated with sales of Osteocel is comprised of payments to tissue banks,direct labor costs and the costs of processing, testing and preservingOsteocel, plus allocated costs of our facilities and overhead. The gross profiton Osteocel sales for the three months ended September 30, 2007 was 54%,compared with 56% for the comparable period in 2006.

 

*Research and Development Expenses*

 

Research and developmentexpenses were approximately $10.8 million for the three months endedSeptember 30, 2007 compared to $9.2 million for the comparable period in2006, reflecting the increase in our clinical trial activities.

 

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*General and Administrative Expenses*

 

General and administrativeexpenses were $1.7 million for the three months ended September 30, 2007compared to $5.3 million in the corresponding period in fiscal 2006. The2006 expenses include $4.4 million in non-cash share-based compensation chargesrelated to certain options that vested upon the completion of our initialpublic offering pursuant to employment agreements, and the value of a warrantthat became determinable upon the completion of our initial public offering.General and administrative expenses in the third quarter of 2006 exclusive ofthese non-cash charges were $0.9 million. The increase in general andadministrative expenses exclusive of non-cash charges in the third quarter of2007, as compared to the same period last year, exclusive of non-cash charges,was attributable primarily to additional personnel and related costs to supportgrowth, and costs incurred as a result of our status as a public company.

 

*Interest Expense, Net*

 

Interest expense, net was$0.3 million for the three months ended September 30, 2007 compared to$2.8 million in the corresponding period in fiscal 2006. The 2006 expensesinclude the recognition of previously deferred financing costs and premiumsassociated with debt that was converted into common stock at the completion ofour initial public offering. Excluding items related to the initial publicoffering, net interest expense for the third quarter of 2006 was $0.1 million.

 

***Comparison of the Nine Months endedSeptember 30, 2007 and 2006***

 

*Revenue*

 

Total revenues increased 63%to $10.1 million for the nine months ended September 30, 2007, compared to$6.2 million in the corresponding period in 2006. Our revenues for thenine months ended September 30, 2007 resulted primarily from $9.3 milliongenerated from the sale of Osteocel and the recognition of $0.9 million inlicensing fees and royalties. In the nine months ended September 30, 2006, werecognized $5.3 million from the sale of Osteocel and $0.9 million inlicense fees and royalties.

 

*Cost of Goods Sold*

 

Cost of goods sold were $4.2million for the nine months ended September 30, 2007 compared to $2.4 millionin the corresponding period in fiscal 2006. The cost of goods sold associatedwith sales of Osteocel is comprised of payments to tissue banks, direct laborcosts and the costs of processing, testing and preserving Osteocel, plusallocated costs of our facilities and overhead. The gross profit on Osteocelsales for the nine months ended September 30, 2007 was 54%, compared with 56%for the comparable period in 2006.

 

*Research and Development Expenses*

 

Research and developmentexpenses were approximately $32.5 million for the nine months endedSeptember 30, 2007 compared to $24.5 million for the comparable periodlast year.  The increase in research and development expenses in the firstnine months of fiscal 2007 when compared to the same period in 2006 wasprimarily driven by the advancement of our clinical programs and the costsof the production qualification runs associated with the expansion of ourOsteocel manufacturing facilities during the first quarter of 2007, which wereapproximately $2.4 million.

 

*General and Administrative Expenses*

 

General and administrativeexpenses were $4.7 million for the nine months ended September 30, 2007compared to $7.6 million for the comparable period last year. The 2006expenses include $4.4 million of non-cash charges associated with thecompletion of our initial public offering. Exclusive of these charges, generaland administrative expenses for the nine months ended September 30, 2006 were$3.2 million. The increase in general and administrative expenses exclusive ofnon-cash charges in 2007, as compared to the corresponding period in fiscal2006, was attributable primarily to additional personnel and related costs tosupport growth, and costs incurred as a result of our status as a publiccompany.

 

*Interest Expense, Net*

 

Interest expense, net, was$1.1 million for the nine months ended September 30, 2007 compared to$4.0 million in the corresponding period in fiscal 2006. The 2006 expensesinclude $2.7 million of previously deferred debt financing costs and premiumsassociated with debt that was converted into common stock upon the completionof our initial public offering. Exclusive of these charges, net interestexpense during the corresponding period of 2006 was $1.3 million.

 

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**Liquidity and Capital Resources**

 

***Liquidity***

 

At September 30, 2007, wehad $22.3 million in cash and short-term investments. In addition to the cashand short-term investments, at September 30, 2007, we had drawn only$5.0 million of the $50.0 million line of credit available for thedevelopment of Provacel under a loan agreement with a  largepharmaceutical company. This $5.0 million draw occurred in March 2004. Inconnection with this line of credit, we have granted the pharmaceutical companya security interest in the intellectual property, equipment and books andrecords involved in the development, manufacture and distribution of Provacel.The pharmaceutical company is also obligated to make additional investments inus and pay licensing fees up to $45.0 million to us upon completion ofcertain milestones.

 

In October 2007, we obtaineda $30.0 million financing commitment from Friedli Corporate Finance, Inc.,which is owned by Peter Friedli who is the Chairman of our Board of Directorsand largest shareholder. This financing commitment is for a twelve month termand provides for financing through the issuance by us of common stock issued ata price determined as the basis of market value, or 3-year promissory notesbearing interest at LIBOR plus 4%. Although we control the timing of draws madeduring the term of the commitment, if any, Friedli Corporate Finance, Inc.determines whether we issue common stock or promissory notes, subject, howeverto limitations as to the aggregate number of shares of common stock that may beissued. We did not incur any fees in connection with this financing commitment.

 

In addition to the$5.0 million balance on the line of credit, at June 30, 2007, our debtincluded  $20.0 million ofconvertible promissory notes due in April 2009.

 

***Cash Flows***

 

Net cash used in operatingactivities was $8.9 million for the three months ended September 30, 2007primarily reflecting our net loss of $10.4 million and net favorable changes inour working capital of $0.6 million, and $0.9 million in non-cashexpenses.  During the third quarter of 2007, we built up our inventoryassociated with Osteocel in connection with our expanded manufacturingfacilities and the resulting increase in sales.  Net cash used inoperating activities for the third quarter of 2006 was $9.3 million, primarilyreflecting a net loss of $15.6 million, which was partially offset by $3.2million in unfavorable working capital changes and $9.5 million in non-cashinterest expense, share-based payments and depreciation and amortization. Themajority of the non-cash interest expense and share-based payments incurred in2006 were related to the completion of our initial public offering.

 

Net cash used in operatingactivities was $31.7 million for the nine months ended September 30, 2007,compared to $22.5 million for the nine month period ended September 30, 2006.

 

Net cash provided byinvesting activities was $9.1 million for the three months ended September 30,2007, including $1.9 million of capital expenditures spent primarily onour  manufacturing facilities inColumbia, Maryland, partially offset by the sale of $11.0 million of short-terminvestments. Net cash used in investing activity for the three monthsended September 30, 2006 was $24.5 million. In the third quarter of 2006 weinvested the net proceeds from our initial public offering in short-terminvestments and had purchases of property and equipment of $0.2 million.

 

Net cash provided byinvesting activities for the nine months ended September 30, 2007 was $12.9million, which included $4.2 million of capital expenditures and the net saleof $17.1 million of short-term investments.  Net cash used in investing activitiesfor the corresponding period of 2006 was $10.2 million, including the net saleof $9.2 million of short-term investments.

 

Net cash used in financingactivities was $0.4 million for the three months ended September 30, 2007. Thisincludes scheduled payments on our capital leases and notes, as well asexpenses incurred in connection with the $20.0 million private placement of ourcommon stock in June 2007, through Friedli Corporate Finance, Inc. Net cashprovided by financing activities was $34.5 million for the three months endedSeptember 30, 2006, composed primarily of the net proceeds from our initialpublic offering.

 

Net cash provided byfinancing activities for the nine months ended September 30, 2007 was $18.7million, which is primarily the result of the $20.0 million private placementof our common stock through the efforts of Friedli Corporate Finance.  Netcash provided by financing activities for the corresponding period of 2006 was$33.9 million, this resulted from our initial public offering.

 

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***Capital Resources***

 

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

 

•                       the level of cash flows from Osteocel sales;

 

•                       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 building and operating ourmanufacturing facilities, both in the near term to support Osteocel sales andour clinical activities and also in anticipation of expanding ourcommercialization activities;

 

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

 

•                       the costs of repaying our debt; and

 

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

 

As a result of these andother factors, we will likely need or choose to seek additional funding priorto our becoming cash flow positive on an operational basis. We would likelyseek such funding through public or private financings or some combination ofthem. Although not our current focus, we might also seek funding throughcollaborative arrangements if determined to be necessary or appropriate. We arealso pursuing government contracts in an effort to help offset the remainingdevelopment costs and reduce adoption risks by securing advanced purchasecommitments for Prochymal. Additional funding may not be available to us onacceptable terms, or at all. If we obtain capital through collaborativearrangements, these arrangements could require us to relinquish rights to ourtechnologies or biologic drug candidates. If we raise capital through the saleof equity, or securities convertible into equity, dilution to our then existingstockholders would result. If we raise additional capital through theincurrence of debt, we would likely become subject to covenants restricting ourbusiness activities, and holders of debt instruments would have rights andprivileges senior to those of our equity investors. In addition, servicing theinterest and repayment obligations under these borrowings would divert fundsthat would otherwise be available to support research and development, clinicalor commercialization activities.

 

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

 

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

 

**Off-Balance Sheet Arrangements.**

 

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

 

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

 

Due to the short duration ofour investment portfolio and the high quality of our investments, an immediate10% change in interest rates would not have a material effect on the fairmarket value of our portfolio. Therefore, we would not expect our operatingresults or cash flows to be affected to any significant degree by the effect ofa sudden change in market interest rates on our securities portfolio.

 

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

 

We do not enter into hedgingor derivative instrument arrangements.

 

**Item 4.               Controls and Procedures.**

 

***Evaluation of Disclosure Controls and Procedures.*** An evaluation of the effectiveness of thedesign and operation of our “disclosure controls and procedures” (as defined inRule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as ofthe end of the period covered by this Quarterly Report on Form 10-Q was madeunder the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer. Based upon thisevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures (a) are effective toensure that information required to be disclosed by us in reports filed orsubmitted under the Securities Exchange Act of 1934 is timely recorded,processed, summarized and reported and (b) include, without limitation,controls and procedures designed to ensure that information required to be disclosedby us in reports filed or submitted under the Securities Exchange Act of 1934is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

***Changes in Internal Control over Financial Reporting.*** There have not been any changes in ourinternal control over financial reporting that occurred during the quarterended September 30, 2007 that have materially affected, or are reasonablylikely to materially affect, our internal control over 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 currently a party to any material pending legalproceedings.

 

**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 for the fiscalyear ended December 31, 2006, filed with the Securities and Exchange Commissionon March 26, 2007.

 

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

 

**PrivatePlacement**

 

On June 8, 2007, we sold1,757,469 shares of our common stock in a private placement at $11.38 pershare, through the efforts of Friedli Corporate Finance, Inc., raising $20.0million. The shares were sold under Regulation S promulgated under theSecurities Act of 1933 as amended (the “Securities Act”), to institutional andaccredited investors primarily based in Switzerland.  There were nocommissions paid on the proceeds raised.  The proceeds from the privateplacement are intended to be used to fund further development of the Company’sadult stem cell products. We deposited the proceeds in two highly ratedfinancial institutions in the United States.

 

The private placement wasled by Peter Friedli, our Chairman of the Board of Directors and our largestshareholder.  Mr. Friedli is also the President and sole owner of FriedliCorporate Finance, Inc.  Included among the purchasers of the common stockwas Peter Friedli, individually, who invested $14.0 million and New Venturetec,Inc., a Swiss publicly traded company approximately 3% owned by Mr. Friedli whoserves as its President, that invested $3.0 million. Our Board of Directors,including all the independent directors, but with Mr. Friedli abstaining,unanimously approved the offer and sale of the common stock, including the saleof a portion of the offering to Mr. Friedli and New Venturetec, Inc., and thearrangements with Friedli Corporate Finance, Inc.

 

The securities sold in theprivate placement have not been registered under the Securities Act or anystate securities laws and may not be offered or sold within the United Statesor to U.S. Persons unless registered under the U.S. Securities Act andapplicable state securities laws or unless an exemption from such registrationis available.  Pursuant to the terms of the private placement, the holdersare provided demand registration rights for the shares of common stock.

 

**InitialPublic Offering**

 

On August 4, 2006, we sold3,500,000 shares of our common stock in our initial public offering at theprice to the public of $11.00 per share.  The offer and sale of all of theshares in the offering were registered under the Securities Act of 1933, asamended, pursuant to a registration statement on Form S-1 (File No. 333-13407),which was declared effective by the Securities and Exchange Commission onAugust 3, 2006.  The underwriters of the offering were Jefferies &Company, Inc., Lazard Capital Markets, LLC and Leerink Swann & Co.,Inc.  There were no selling stockholders in the offering.

 

We registered 3,500,000shares of our common stock in connection with the initial public offering andthe aggregate offering amount was $38.5 million.  We paid approximately$2.7 million in underwriting discounts and commissions to theunderwriters.  We also incurred other expenses in connection with theoffering of approximately $1.4 million, including registration fees, accountingand legal, printing and engraving and other expenses.

 

None of the underwritingdiscounts and commissions or offering expenses that were incurred were paid todirectors or officers of ours or their associates, to persons owning 10 percentor more of our common stock or to any affiliates of ours.  After deductingthe underwriting discounts and commissions and these other estimated offeringexpenses, our net proceeds from the offering were approximately $34.4million.  We deposited the net proceeds in two highly rated financialinstitutions in the United States.

 

There has been no materialchange in our planned use of proceeds from our initial public offering asdescribed in our final prospectus filed with the Securities and ExchangeCommission pursuant to Rule 424(b).  Between August 4, 2006 andSeptember 30, 2007, we used approximately all of the net proceeds from ourinitial public offering to fund our operating activities, including activitiesrelating to the development of our biologic drug candidates and for workingcapital, capital expenditures, repayment of debt and other general corporatepurposes.  During this period, our research and development expensescomprised approximately 90% of our operating expenses.  The remainingapproximately $2.0 million in net proceeds remains on deposit in two highlyrated financial institutions in the United States.  At September 30, 2007,we had $22.3 million in cash and short-term investments.

 

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

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                                                                       |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                       |
| *10.1               |       | Letter Agreement dated  October 3, 2007 between Friedli Corporate Finance, Inc. and the Registrant  (together with forms of subscription agreements and promissory note), establishing  the terms of the $30 million financing commitment. |
|                |       |                                                                                                                                                                                                                                       |
| **10.2              |       | Amendment to Lock-up  Agreement acknowledged September 20, 2007, by and between the Registrant and  Peter Friedli and Venturetec, Inc., amending the terms of the Lock-up  Agreement dated October 31, 2006.                               |
|                |       |                                                                                                                                                                                                                                       |
| 31.1                |       | Certification of Principal  Executive Officer pursuant to Rule 13a-14(a) and 15D-14(a) under the  Securities Exchange Act of 1934, as amended (Section 302 of the  Sarbanes-Oxley Act of 2002).                                            |
|                |       |                                                                                                                                                                                                                                       |
| 31.2                |       | Certification of Principal  Financial Officer pursuant to Rule 13a-14(a) and 15D-14(a) under the  Securities Exchange Act of 1934, as amended (Section 302 of the  Sarbanes-Oxley Act of 2002).                                            |
|                |       |                                                                                                                                                                                                                                       |
| 32                  |       | Certification of Principal  Executive Officer and Principal Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                  |
|                |       |                                                                                                                                                                                                                                       |
| *                   |       | Incorporated herein by  reference to Current Report on Form 8-K filed by the Registrant with the SEC  on October 10, 2007.                                                                                                                 |
|                |       |                                                                                                                                                                                                                                       |
| **                  |       | Incorporated herein by  reference to Current Report on Form 8-K filed by the Registrant with the SEC  on September 20, 2007.                                                                                                               |

 

The certification attachedas Exhibit 32 that accompanies this Quarterly Report on Form 10-Q is not deemedfiled with the Securities and Exchange Commission and is not to be incorporatedby reference into any filing of Osiris Therapeutics, Inc. under the SecuritiesAct of 1933, as amended, or the Securities Exchange Act of 1934, as amended,whether made before or after the date of this Quarterly Report on Form 10-Q,irrespective of any general incorporation language contained in such filing.

 

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**SIGNATURE**

 

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

 
|                    |   | **Osiris  Therapeutics, Inc.** |
|-------------------------|--------|--------------------------------|
|                    |   |                           |
| Date: November 13, 2007 |   | /s/ Cary J. Claiborne          |
|                    |   | Cary J. Claiborne              |
|                    |   | Chief Financial Officer        |

 

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