10-K 1 a2213414z10-k.htm 10-K

Use these links to rapidly review the document
TABLE OF CONTENTS
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K


ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:

For the fiscal year ended December 31, 2012

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:

For the transition period from                to                

Commission file number 001-32966

Osiris Therapeutics, Inc.
(Exact name of registrant as specified in its charter)

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

7015 Albert Einstein Drive, Columbia, Maryland
(Address of principal executive offices)

 

21046-1707
(Zip Code)

443-545-1800
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class   Name of Each Exchange on with Registered
Common Stock, $0.001 par value   NASDAQ Global Market

         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

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

         Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

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

         On June 30, 2012, the last business day of the registrant's most recently completed second fiscal quarter, the aggregate market value of voting Common Stock held by non-affiliates of the registrant, based upon the last sale price of the Common Stock reported on the NASDAQ Global Market was approximately $201,559,225.

         The number of shares of the registrant's Common Stock outstanding as of March 10, 2013 is 32,924,479.

Documents Incorporated by Reference:

         Portions of the Registrant's definitive proxy statement for its 2013 Annual Meeting of Stockholders (the "Proxy Statement") to be filed no later than 120 days after the close of the fiscal year are incorporated herein by reference in Part III.

   


Table of Contents

OSIRIS THERAPEUTICS, INC.
Annual Report on Form 10-K
Fiscal Year Ended December 31, 2012


INDEX

 
   
  Page  

PART I

           

Item 1.

 

Business

    3  

Item 1A.

 

Risk Factors

    27  

Item 1B.

 

Unresolved Staff Comments

    47  

Item 2.

 

Properties

    47  

Item 3.

 

Legal Proceedings

    47  

Item 4.

 

Mine Safety Disclosures

    47  

PART II

           

Item 5.

 

Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

    48  

Item 6.

 

Selected Financial Data

    50  

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    51  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

    66  

Item 8.

 

Financial Statements and Supplementary Data

    67  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

    99  

Item 9A.

 

Controls and Procedures

    99  

Item 9B.

 

Other Information

    99  

PART III

           

Item 10.

 

Directors, Executive Officers and Corporate Governance

    99  

Item 11.

 

Executive Compensation

    100  

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

    100  

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

    100  

Item 14.

 

Principal Accounting Fees and Services

    100  

PART IV

           

Item 15.

 

Exhibits, Financial Statement Schedules

    100  

2


Table of Contents


PART I

ITEM 1.    Business.

CAUTIONARY STATEMENTS ABOUT FORWARD-LOOKING INFORMATION

        This Annual Report on Form 10-K includes "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. Statements included or incorporated herein which are not historical facts are forward looking statements. When used in this Annual Report, the words estimates, expects, anticipates, projects, plans, intends, believes, forecasts and variations of such words or similar expressions are intended to identify forward-looking statements, but these terms are not the exclusive means of identifying forward looking statements.

        Forward looking statements reflect management's current views with respect to future events and performance and are based on currently available information and management's assumptions regarding future events. While management believes that its assumptions are reasonable, forward-looking statements are subject to various known and unknown risks and uncertainties and actual results may differ materially from those expressed or implied herein. In connection with the "safe harbor provisions" of the Private Securities Litigation Reform Act of 1995, the Company notes that certain factors, among others, which could cause future results to differ materially from the forward-looking statements, expectations and assumptions expressed or implied herein are discussed in greater detail under Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 1A "Risk Factors," and may be discussed elsewhere herein or in other documents we file with the Securities and Exchange Commission, or SEC. Examples of forward-looking statements may include, without limitation, statements regarding any of the following: our product development efforts; our clinical trials and anticipated regulatory requirements, and our ability to successfully navigate these requirements; the success of our product candidates in development; status of the regulatory process for our biologic drug candidates; implementation of our corporate strategy; our financial performance; our product research and development activities and projected expenditures, including our anticipated timeline and clinical and commercialization strategy for mesenchymal stem cells (MSCs) and biologic drug products and product candidates (including Prochymal® and Chondrogen™), and marketed biosurgery products (including Grafix® and Ovation®); our cash needs; patents, trademarks and other proprietary rights; the safety and ability of our products and potential products to treat disease; our ability to supply a sufficient amount of our product candidates and, if or insofar as approved or otherwise commercially available, our products to meet demand; our costs to comply with governmental regulations; our plans for or success of sales and marketing; our plans regarding facilities; our ability to establish and maintain reimbursement for our commercially available products; types and the anticipated impact of regulatory frameworks applicable to our products and potential products; and results of our scientific research.

        Readers are cautioned that all forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Annual Report and are expressly qualified in their entirety by the cautionary statements included herein. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances and do not intend to do so.

        When we use the terms "Osiris," "we," "us," and "our" we mean Osiris Therapeutics, Inc., a Maryland corporation.

Company Overview

        We are a leading stem cell company headquartered in Columbia, Maryland and focused on developing and marketing products to treat medical conditions in the inflammatory, cardiovascular, orthopedic and wound healing markets. We have two business segments, Biosurgery and Therapeutics.

3


Table of Contents

Our Biosurgery business, operating as a separate segment since 2010, works to harness the ability of cells and novel constructs to promote the body's natural healing with the goals of improving surgical outcomes and offering better treatment options for patients and physicians. Our Therapeutics business is focused on developing biologic stem cell drug candidates from a readily available and non-controversial source—adult bone marrow.

        In our Biosurgery business, we currently manufacture, market and distribute Grafix and Ovation for tissue repair. In our Therapeutics segment, our pipeline of internally developed biologic drug candidates under evaluation includes Prochymal for inflammatory, autoimmune and cardiovascular indications, as well as Chondrogen for arthritis in the knee. We believe our stem cell therapeutic products have significant therapeutic potential because of their ability to regulate inflammation, promote tissue regeneration and prevent pathological scar formation. We are a fully integrated company, with capabilities in research, development, manufacturing and distribution of stem cell products.

        We began operations on December 23, 1992 and were a Delaware corporation until, with approval of our stockholders, we reincorporated as a Maryland corporation on May 31, 2010.

        Biosurgery Segment.    Our Biosurgery segment seeks to harness the ability of cells and novel constructs to promote the body's natural healing, with the goals of improving surgical outcomes and offering better treatment options for patients and physicians. During the third quarter of 2010, we launched limited commercial distribution of several Biosurgery segment products, including Grafix and Ovation, both of which we developed and manufacture. We intend to build on the success of our first generation implantable product, Osteocel® for regenerating bone in orthopedic indications. Disease targets for Biosurgery products commercialized or in development include diabetic foot ulcers, venous stasis ulcers, dermal burns, and various orthopedic conditions.

        Grafix is a three-dimensional tissue matrix designed for application directly to acute and chronic wounds, including but not limited to diabetic foot ulcers and burns. Flexible and conformable to complex anatomies, this cellular repair matrix provides a rich source of extracellular matrix, viable endogenous MSCs and epithelial cells, as well as growth factors directly to the site of the wound, protecting the area from inflammation, scarring and infection.

        Ovation is a novel cellular repair matrix designed for use in surgical applications. Easily applied to the site of injury, Ovation provides three essential components—collagen matrix, viable endogenous MSCs and key growth factors such as BMPs and VEGF—to support tissue regeneration.

        Grafix and Ovation are regulated by the FDA under 21CFR Part 1271, Human Cells, Tissues and Cellular and Tissue-based Products ("HCT/Ps"). We are registered with the FDA as a tissue establishment and are accredited by the American Association of Tissue Banks ("AATB"). Extensive donor screening, serological testing, bioburden testing and sterility testing is performed on every lot to demonstrate suitability for transplantation. Our Biosurgery products are all manufactured in our Columbia, Maryland facility. Each lot is tested to confirm viable cell content post thaw.

        We market and distribute both Grafix and Ovation through a network of distributors as well as directly to hospitals and clinics. A significant market for Grafix is chronic wounds, which are primarily treated in the outpatient setting, and to obtain full reimbursement for use in the outpatient setting, a prospective randomized clinical trial comparing the standard of care to Grafix was initiated during the second fiscal quarter of 2012.

        This is a multicenter, adaptive design, randomized study to evaluate the efficacy and safety of Grafix for the treatment of chronic diabetic foot ulcers. Up to 266 patients will be enrolled in this study and will receive either Grafix or a control dressing for a chronic diabetic foot ulcer that is between 1 cm2 and 15 cm2. Patients are randomized in a 1:1 ratio. The primary efficacy endpoint of this study is complete wound closure, defined as 100% re-epithelialization, by week 12. Additional

4


Table of Contents

secondary efficacy endpoints include time to initial wound closure, number of patients with at least 50% reduction in wound size by Day 28 and number of applications of Grafix versus control. This trial is being conducted at 20 wound care clinics across the US and is currently enrolling patients.

        We have received transitional pass-through status from the Center for Medicare & Medicaid Services ("CMS"), with C-Codes being designated for Grafix. Further, the product has been assigned pass-through status under Medicare's outpatient prospective payment system ("OPPS"), effective July 1, 2012. CMS has also issued permanent Healthcare Common Procedure Coding System (HCPCS) Q-codes for Grafix, which will assist physicians in facilitating reimbursement in the commercial and Medicare patient populations.

        Therapeutics Segment.    Our Therapeutics segment is focused on developing biologic stem cell drug candidates from a readily available and non-controversial source—adult bone marrow. Our lead biologic drug candidate, Prochymal (remestemcel-L), is being evaluated in clinical trials for a number of indications, including acute graft versus host disease ("GvHD"), Crohn's disease, and acute myocardial infarction. Prochymal is the only stem cell therapeutic currently granted both Orphan Drug and Fast Track status by the United States Food and Drug Administration ("FDA").

        In May 2012, we received approval from Health Canada to market Prochymal for the treatment of refractory acute GvHD in children. We believe this is the world's first regulatory approval of a stem cell therapeutic drug product and the first therapy approved specifically for GvHD, a devastating complication of bone marrow transplantation that kills up to 80 percent of children affected, many within just weeks of diagnosis. We subsequently also received approval from Medsafe in New Zealand for the same indication.

        Prochymal was approved under Health Canada's Notice of Compliance with conditions (NOC/c) Policy, which provides expedited market clearance to high quality medical products that address significant unmet medical conditions and which have demonstrated favorable risk/benefit profile in clinical trials. Under the NOC/c pathway, the sponsor must agree to carry out confirmatory clinical testing.

        Health Canada's approval was made following the recommendation of an independent expert advisory panel commissioned to evaluate Prochymal's safety and efficacy. In support of the application, Osiris submitted over 90,000 pages of data generated over a 20 year development cycle. In Canada, Prochymal is now approved for the management of acute GvHD in children who fail to respond to steroids. The approval was based on the results from clinical studies evaluating Prochymal in patients with severe refractory acute GvHD. Prochymal demonstrated a clinically significant response 28 days post initiation of therapy in 61-64 percent of patients treated. Furthermore, treatment with Prochymal resulted in a statistically significant improvement in survival when compared to an historical control population of pediatric patients with refractory GvHD (p=0.028). The survival benefit was most pronounced in patients with the most severe forms of GvHD. As a condition of approval, the clinical benefit of Prochymal will be further evaluated in a case-matched confirmatory study.

        In addition to the extensive patent protection for Prochymal, Health Canada's decision will also provide Prochymal with regulatory exclusivity within the territory for the approved pediatric application. Canada affords eight years of exclusivity to Innovative Drugs such as Prochymal, and an additional six-month pediatric extension is available since it is intended to treat a pediatric population.

        In the fourth quarter of 2008, we entered into a collaboration agreement with Genzyme Corporation, then an independent and now a Sanofi company, for the development and commercialization of Prochymal and Chondrogen. Under the terms of the agreement, we retained the rights to commercialize Prochymal and Chondrogen in the United States and Canada, and Genzyme was provided the exclusive right to commercialize the treatments in all other countries except with

5


Table of Contents

respect to GvHD in Japan, where JCR Pharmaceuticals Co., Ltd. has these rights. Under the agreement, we were paid $130.0 million for these rights.

        In September 2012, we reached agreement with Sanofi to conclude the Collaboration Agreement without either party having any continuing obligation to the other. As a result, all rights formerly licensed to Genzyme have since reverted to us. We are continuing to proceed with our Prochymal regulatory approval and commercialization efforts.

        Our two biologic drug candidates, Prochymal and Chondrogen, utilize human mesenchymal stem cells, also referred to as MSCs. MSCs can selectively differentiate, based on the tissue environment, into various tissue lineages such as bone, muscle, fat, tendon, ligament, cartilage and bone marrow stroma. In addition, MSCs have anti-inflammatory properties and can prevent fibrosis or scarring. These characteristics give MSCs the potential to treat a wide variety of medical conditions. We believe that our biologic drug candidates have advantages over other stem cell therapeutics in development for the following reasons:

    Stem Cell Source.  Our stem cells are obtained from adult bone marrow, a readily available source. The cells are drawn from the hips of volunteer donors between the ages of 18 and 30 years, using a simple needle and syringe aspiration. Because the cells are obtained from consenting adult donors, we are able to largely avoid the ethical controversy surrounding embryonic and fetal stem cell research.

    Ability to Mass Produce.  Through our proprietary manufacturing methods, we can grow MSCs in a controlled fashion to produce up to 10,000 treatments of our biologic drug candidates from a single bone marrow donation. Our ability to produce a large quantity of treatments from one donation provides us with manufacturing efficiencies and product consistency that are essential to commercialization.

    Universal Compatibility.  Many stem cell therapies under development can elicit a rejection response in the recipient and therefore require donor-to-recipient matching or potentially harmful immunosuppression. This greatly reduces manufacturing efficiencies and creates a risk of mismatch which can result in an acute inflammatory response leading to serious medical complications and can even be fatal. Based on our clinical experience, we believe that our biologic drug candidates are not rejected by the patient's immune system and so, like type O negative blood, do not require matching. This universal compatibility allows us to produce a standardized product available to all patients in almost any medical setting.

    Treatment on Demand.  Our biologic drug candidates can be stored frozen at end-user medical facilities until they are needed. We anticipate that medical facilities will be able to prescribe and dispense these products in much the same way as conventional drugs. In contrast, other stem cell technologies under development require weeks to prepare after a patient's need is identified. This is a key feature of our technology, as many patients in the critical care setting require prompt treatment.



        We expended approximately $14.1 million in fiscal 2012, $19.2 million in fiscal 2011, and $23.5 million in fiscal 2010 on research and development. In fiscal 2012, we recognized the remaining $3.3 million of revenue from the Genzyme collaborative agreement. In both fiscal 2011 and 2010, we recognized $40.0 million of revenue from the Genzyme collaborative agreement. In fiscal 2011, we earned $960,000 from our collaboration with the Juvenile Diabetes Research Foundation, or JDRF, for the development of Prochymal as a treatment for the preservation of insulin production in type 1 diabetes patients. In fiscal 2010, we were reimbursed for $471,000 of research and development expenditures through our contract with the United States Department of Defense, or DoD, for the development and stockpiling of Prochymal for the treatment of acute radiation syndrome, and we

6


Table of Contents

earned $1.2 million in funding from JDRF. For more detailed financial information, including information regarding our revenues, profit and loss, and total assets and research and development costs and expenses for the past three fiscal years, including information by segment, as available, see our Financial Statements included in Item 8 to this Annual Report on Form 10-K for fiscal year 2012.

Clinical Programs—Therapeutics Segment

        The following table summarizes key information about our biologic drug candidates.

Drug Candidate
  Indication   Status
Prochymal   Pediatric Refractory Acute GvHD   Marketing Approval received from Health Canada in May 2012 and from Medsafe (New Zealand's medical regulatory agency) in June 2012
    Refractory Acute GvHD in pediatric and adult patients   Available in eight countries under Expanded Access Programs
    Biologics Refractory Crohn's Disease   Phase 3
    Acute Myocardial Infarction   Phase 2
    Type I Diabetes Mellitus   Phase 2
    Acute Radiation Syndrome   Phase 3(Animal Rule)

Chondrogen

 

Osteoarthritis & Cartilage Protection

 

Phase 2

        Prochymal, our lead biologic drug candidate, is being evaluated in clinical trials for a number of indications including acute GvHD, Crohn's disease, acute myocardial infarction, type 1 diabetes and gastrointestinal injury resulting from radiation exposure (animal rule). Prochymal is currently designated by the FDA as both an Orphan Drug and Fast Track product.

Prochymal for Treatment-Resistant Acute GvHD

        Acute GvHD is a life threatening immune system reaction in patients who have received a bone marrow transplant and commonly affects one or more of the following organs: skin, gastrointestinal tract, and liver. We estimate that there are approximately 3,000 instances of GvHD in the United States each year.

        Bone marrow transplantation is a treatment of last resort for patients with certain cancers and some genetic diseases. This procedure can result in a particularly serious type of rejection referred to as acute GvHD. This condition gets its name because the bone marrow transplant, or the graft, begins to attack the recipient, or the host. As noted in an article published in the journal Biology of Blood and Marrow Transplantation in 2005, acute GvHD is one of the most common complications of allogeneic bone marrow or hematopoietic stem cell transplantation, affecting approximately 50% of transplant patients. Acute GvHD is graded for prognostic and treatment purposes on a four grade scale, with Grades III-IV considered severe and life-threatening. The onset of GvHD in patients who have received a bone marrow transplant leads to a poor prognosis because of the already weakened state of these patients. According to a 2002 article published in Biology of Blood and Marrow Transplantation,

7


Table of Contents

the estimated one-year survival rate for patients with acute GvHD decreases drastically with increasing disease severity, as illustrated below:

Acute GvHD
  Estimated One
Year Survival
 

Grade I

    65 %

Grade II

    60 %

Grade III

    39 %

Grade IV

    22 %

        There are no drugs approved for GvHD in the United States. The disease is commonly treated off-label with steroids and other immunosuppressants. A 2001 article published in the journal Blood noted that approximately 50% of these patients will not respond to first-line treatment with steroids and approximately 50-80% of steroid refractory GvHD patients die of the disease.

        GvHD that does not respond to steroids is known as steroid refractory GvHD. A large majority of steroid refractory GvHD patients die within six months.

        The current off-label treatments used to treat acute GvHD are inadequate in two primary ways. First, mortality in patients with acute GvHD who are undergoing current treatments is extremely high. Second, most treatments for acute GvHD suppress or destroy the immune system. This can lead to a number of debilitating side effects, including severe and life threatening infection. Unlike steroids or other immunosuppressant drugs, which have a systemic effect, Prochymal's mechanism of action is designed to specifically target areas of inflammation. Therefore, we believe the use of Prochymal will result in fewer toxicities.

        Prochymal has been granted Fast Track status by FDA, as well as Orphan Drug status by FDA and the European Medicines Agency, for GvHD.

        In 2008, we received clearance from the FDA to initiate an expanded access treatment program making Prochymal available to children with life threatening GvHD. Under the program, children 2 months to 17 years of age, with Grades II–IV acute GvHD that have not responded to steroids, are eligible for treatment. Upon completion of enrollment of the Phase 3 trials evaluating Prochymal in adults, we received clearance from the FDA to broaden the expanded access treatment program to include patients 18 to 70 years of age. The expanded access treatment programs for Prochymal in treating adult and pediatric patients with refractory GvHD are ongoing.

        We have completed Phase 3 trials evaluating Prochymal in adult and pediatric patients with acute GvHD. We also completed a trial evaluating Prochymal as a rescue therapy in 59 pediatric patients with severe, treatment-resistant acute GvHD. Patients in the study received two intravenous infusions of Prochymal per week for a total of four weeks. At study entry, 88% of children had Grade III/IV GvHD, the most severe forms of GvHD, and were unresponsive to an average of three lines of therapy. Overall response to treatment with Prochymal at 28 days was 63%. Response to Prochymal at day 28 significantly improved survival over those patients whose GvHD progressed (78% vs. 9%, p<0.05). Patients in the trial were treated at 31 pediatric transplant centers across the U.S., Canada, Europe and New Zealand.

        In May 2012, we received approval from the Biologics and Genetic Therapies Directorate of Health Canada, or Health Canada, to market Prochymal (remestemcel-L), for the treatment of refractory acute GvHD in children. We believe this is the world's first regulatory approval of a stem cell drug and the first therapy approved specifically for GvHD, a devastating complication of bone marrow transplantation that kills up to 80 percent of children affected, many within just weeks of diagnosis.

8


Table of Contents

        Prochymal was approved under Health Canada's Notice of Compliance with conditions (NOC/c) Policy, which provides expedited market clearance to high quality medical products that address significant unmet medical conditions and which have demonstrated favorable risk/benefit profile in clinical trials. Under the NOC/c pathway, the sponsor must agree to carry out confirmatory clinical testing.

        Health Canada's approval was made following the recommendation of an independent expert advisory panel commissioned to evaluate Prochymal's safety and efficacy. In support of the application, Osiris submitted over 90,000 pages of data generated over a 20 year development cycle. In Canada, Prochymal is now approved for the management of acute GvHD in children who fail to respond to steroids. The approval was based on the results from clinical studies evaluating Prochymal in patients with severe refractory acute GvHD. Prochymal demonstrated a clinically significant response 28 days post initiation of therapy in 61-64 percent of patients treated. Furthermore, treatment with Prochymal resulted in a statistically significant improvement in survival when compared to an historical control population of pediatric patients with refractory GvHD (p=0.028). The survival benefit was most pronounced in patients with the most severe forms of GvHD. As a condition of approval, the clinical benefit of Prochymal will be further evaluated in a case-matched confirmatory study.

        In addition to the extensive patent protection for Prochymal, Health Canada's decision will also provide Prochymal with regulatory exclusivity within the territory for the approved pediatric application. Canada affords eight years of exclusivity to Innovative Drugs such as Prochymal, and an additional six-month pediatric extension is available since it is intended to treat a pediatric population.

Phase 3 Clinical Trial—Biologics Refractory Crohn's Disease.

        Based on clinical observations of the effects of Prochymal on gastrointestinal GvHD, we are developing Prochymal for the treatment of Crohn's disease. Crohn's disease is a chronic condition that results in inflammation of the gastrointestinal tract. We received Fast Track designation from the FDA for the development of Prochymal for patients with moderate to severe biologics refractory Crohn's disease.

        We completed a Phase 2 trial in 2006 studying Prochymal as a treatment for moderate to severe Crohn's disease that is refractory to steroids and other immunosuppressants. Four leading centers in the United States enrolled a total of ten patients for the prospective, randomized, open label trial. Patients with a Crohn's Disease Activity Index, or CDAI, of at least 220, who had previously failed treatment with steroids and other immunosuppressive agents, received Prochymal infusions. The average CDAI at baseline was 341 for patients in the trial. Patients had suffered from Crohn's disease for an average of 14.2 years, and 80% of the patients required prior surgical intervention to treat their Crohn's disease. Within 14 days of treatment with Prochymal, one-third of the patients had a reduction of CDAI of greater than 100 points and had achieved clinical remission of their disease.

        As a result of the positive data from the Phase 2 trial, a Phase 3 trial (Protocol 603) evaluating Prochymal for the treatment of refractory, moderate to severe Crohn's disease was initiated. The placebo-controlled, double-blind trial was designed to enroll 270 patients, 18 to 70 years of age with a CDAI greater than 250. The primary endpoint of this trial was the proportion of patients with CDAI of less than 150 (clinical remission) at day 28. The trial was initiated at approximately 60 leading centers in the U.S. and Canada. In 2009, enrollment was temporarily suspended on account of concerns about the trial design, discussed below.

        The Crohn's program had initially consisted of two linked Phase 3 trials—one aimed at inducing remission (Protocol 603) and the other at maintaining response (Protocol 610) in patients who had failed other available treatments. The primary endpoint for Protocol 603, which initially included a placebo and two Prochymal dose arms, is the proportion of patients experiencing disease remission within 28 days of initiation of therapy with Prochymal. For the primary endpoint of disease remission,

9


Table of Contents

the CDAI score must fall to below 150. Concerns that the linked trial design (Protocol 610) was biasing response rates led to the suspension of enrollment in Protocol 603. The trial remained blinded following suspension to permit an interim analysis of the 207 patients enrolled. The average CDAI scores at trial entry exceeded 350 in all treatment arms, indicating that the patients had very debilitating disease. For the primary endpoint of disease remission, the interim analysis revealed that one dose arm for Prochymal approached statistical significance in the intent to treat ("ITT") population, and reached significance in the per protocol population. These results showed that despite the initial concerns, the difference in response rates between one dose arm of Prochymal and placebo is consistent with the original statistical assumptions of the protocol, and Prochymal significantly outperformed placebo. Additionally, the analysis showed that Prochymal continued to demonstrate a benign safety profile with no significant differences in safety outcomes compared to placebo. As a result, in April 2010, after discussions with FDA, we announced continuation of enrollment in our Phase 3 Crohn's disease trial (Protocol 603).

        Enrollment is ongoing with the best-performing Prochymal dose arm and the placebo arm, according to the pre-specified, adaptive trial design. The trial has been statistically repowered to compensate for the interim analysis.

Phase 2 Clinical Trial—Acute Myocardial Infarction.

        Prochymal is being evaluated as a therapy to improve heart function in patients who have suffered a heart attack. A heart attack, or acute myocardial infarction, ("AMI"), occurs when coronary arteries become blocked with fatty deposits, depriving the heart muscle of oxygen and nutrients. Based on statistics published in 2005 by the American Stroke Association and the American Heart Association, approximately 700,000 individuals in the United States each year experience their first heart attack. According to these same statistics, approximately 20% of these patients suffer extensive damage to their heart muscle leading to heart failure within six years.

        Prochymal is being developed for the treatment of heart muscle damage following AMI and the prevention of scar tissue formation and associated cardiac dysfunction. Our preclinical studies indicate that the mechanism by which Prochymal improves myocardial function includes the prevention of pathological scarring of the heart muscle and the formation of new blood vessels. We are developing Prochymal as a therapy to be delivered through a standard intravenous line up to 7 days post-AMI.

        The first trial was a 53-patient Phase 1 randomized, double-blind, placebo-controlled clinical study to evaluate Prochymal following AMI. Data at the six-month time point showed that heart attack patients receiving Prochymal had significantly lower rates of adverse events, such as cardiac arrhythmias, as well as significant improvements in heart, lung and global function. Patients in the Prochymal group were four times less likely to experience an arrhythmic event compared to those receiving placebo (9% vs. 37%, p=0.025). Significantly more patients who received Prochymal experienced improvement in their overall condition at six months as compared to those receiving placebo (42% vs. 11%, p=0.027). One year magnetic resonance imaging ("MRI") data on LVEF was showed patients treated with Prochymal had a statistically significant 5.2 point increase over baseline (p=0.021). Patients receiving placebo showed only a 1.8 point improvement over baseline, which was not statistically significant.

        Data from the final two-year time point was reported in February 2009 and indicated a continuing benefit from treatment with Prochymal. The trial met its primary endpoint demonstrating the safety of Prochymal in the acute myocardial infarction setting. Administration of Prochymal was found to be well tolerated at all dose levels. Patients receiving Prochymal experienced fewer adverse events than that of placebo (8 vs. 11 per patient). Throughout the trial, patients receiving Prochymal experienced fewer arrhythmias. This effect was maintained for the duration of the study, with 47.4% of placebo patients experiencing cardiac arrhythmia compared to only 11.8% of Prochymal patients (p=0.006). Ventricular

10


Table of Contents

arrhythmias are associated with tissue damage and scar formation in the heart and can be a sign of poorer prognosis. For patients with severe myocardial infarction, defined as a baseline LVEF of 45% or less, greater effects were observed. The Prochymal group showed a significant 9.5 point improvement over baseline two years post-treatment (p<0.05). This compares favorably to the 3.1 point increase observed for the placebo group. All-cause hospitalizations also trended lower in the Prochymal group (38.2%) as compared to the placebo group (47.4%).

        Based upon the positive results from the Phase 1 trial, we received approval from the FDA to initiate a Phase 2 trial. The trial is the largest study of allogeneic or "off-the-shelf" stem cells ever conducted in heart attack patients. The double-blind, placebo-controlled trial is evaluating the safety and efficacy of Prochymal in conjunction with standard of care for improving heart function in patients who experienced a first heart attack. This trial focuses on patients who have suffered a severe myocardial infarction, defined as LVEF between 20% and 45% at baseline. Enrollment of 220 patients was completed in March 2011 at 33 leading centers in the United States and Canada. Patients were randomized to Prochymal or placebo at a 1:1 ratio. Efficacy endpoints involve cardiac MRI, functional and quality of life assessments.

        Interim results were reported in July 2012. Cardiac MRI assessments were conducted for six months following infarct to evaluate cardiac remodeling. Patients receiving Prochymal had significantly less cardiac hypertrophy, as measured by cardiac MRI, compared to patients receiving placebo (p<0.05). Patients treated with Prochymal also experienced significantly less stress-induced ventricular arrhythmia (p<0.05). Cardiac hypertrophy and ventricular arrhythmia are indicators of pathological remodeling following heart injury and provide insight into the mechanism by which MSCs may attenuate heart injury following AMI. Prochymal also demonstrated a positive safety profile. There were no infusional toxicities observed in patients receiving Prochymal. Serious adverse events occurred with equal frequency in both treatment groups (31.8%).

        The mechanistic data is complemented by clinical data showing treatment with Prochymal resulted in a statistically significant reduction in heart failure. In the study, seven patients who were treated with placebo have progressed to heart failure requiring treatment with intravenous diuretics, compared to none of the Prochymal patients (p=0.01). Furthermore, patients receiving placebo tended to require re-hospitalization for cardiac issues sooner than the patients receiving Prochymal (median 27.5 days vs. 85.5 days). Given the results observed at the one year time-point, the trial has been extended to include 5 years of follow-up.

Phase 2 Clinical Trial—Early Onset Type 1 Diabetes Mellitus.

        We are also investigating Prochymal as a treatment for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. Type 1 diabetes, commonly known as juvenile diabetes or insulin-dependent diabetes, is an autoimmune disorder that attacks and destroys insulin producing islet cells in the pancreas causing glucose accumulation. As a result, those suffering from type 1 diabetes must take insulin to regulate blood sugar levels. Over time, poorly controlled diabetes can lead to serious health conditions, including heart disease, stroke, blindness, amputations, kidney disease and nerve damage. Both animal and human bone marrow-derived MSCs have been shown to preserve islet cell function in animal models of diabetes.

        In October 2007, we reported the initiation of a Phase 2 trial evaluating Prochymal in conjunction with standard of care in preserving insulin production in patients aged 12 to 35 years. Patients must have been diagnosed with type 1 diabetes mellitus within 2 to 20 weeks of enrollment. Patients in the double-blind, placebo-controlled study received three intravenous infusions of Prochymal over the course of sixty days. The primary efficacy endpoint is the amount of C-peptide produced during a Mixed Meal Tolerance Test at one year. This test is frequently used in diabetic patients to determine

11


Table of Contents

how much insulin is being produced by the pancreas in response to glucose stimulation. In early 2010, enrollment was completed with a total of 63 patients.

        We entered into a collaborative agreement with the Juvenile Diabetes Research Foundation, or JDRF, for this study. Under this agreement, the JDRF committed to fund $4.0 million of clinical study costs contingent upon us meeting specific milestones. We achieved all of the contingent milestones as of December 31, 2010 and have received full payment from the JDRF. In January 2012, we provided an update on this first-of-its-kind trial. The interim assessment at one year showed that systemic infusions of Prochymal were well-tolerated in this unique population. There were no differences in adverse event rates between the Prochymal and placebo groups. Importantly, no patients experienced a reaction to the infusions despite the cells being unrelated to the recipient, unmatched, and used without immunosuppression. No significant differences in the rates of disease progression, as measured by stimulated C-peptide levels at the one year time point, have been observed. However there was a trend towards fewer hypoglycemic events for patients treated with Prochymal as compared to controls. The patients will be followed for a total of two years. At present, we have no further trials planned for this indication.

Phase 3 Development—Animal Rule—Acute Radiation Syndrome.

        In 2007, we partnered with Genzyme Corporation to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from DoD for the development and stockpiling of Prochymal for the treatment of acute radiation syndrome ("ARS"). We completed our work on the DoD contract in fiscal 2010 and are not pursuing any further contracts on nuclear countermeasures. Our agreement with Genzyme for nuclear countermeasures expired in July 2010, in accordance with its terms.

Chondrogen

        Chondrogen is our biologic drug candidate for knee repair. Chondrogen, a preparation of adult MSCs formulated for direct injection into the knee, regenerated meniscus and prevented osteoarthritis in animal models. As described further below, we completed a Phase 1/2 clinical trial for Chondrogen, designed to evaluate the safety and preliminary efficacy in patients following surgery to remove torn meniscus. The current standard of care for significant injuries to the meniscus is partial meniscectomy surgery, in which the damaged portion of the meniscus is permanently removed. As noted in a 1999 article in the journal Sports Medicine, patients after meniscectomy are 10 to 15 times more likely to develop osteoarthritis, a highly debilitating orthopedic condition. As a result, a significant medical need exists for a product that can prevent cartilage degeneration.

        In the randomized double-blind, placebo-controlled Phase 1/2 clinical trial evaluating Chondrogen, 55 patients received one of two doses of Chondrogen or vehicle control. At one-year, 23.5% of patients in the 50 × 106 cells Chondrogen arm had at least a 15% meniscal volume increase on MRI, compared to no patients in the placebo group (p=0.04). At one-year, the data showed improvements in joint condition that correlated with a clinically and statistically significant improvement in pain in patients with osteoarthritis ("OA") who received Chondrogen as compared to those treated with the control, hyaluronic acid ("HA"). The effects were dose dependent and maintained through two-years. The two-year follow-up also showed that Chondrogen continued to demonstrate a positive safety profile. Chondrogen was well tolerated and was not associated with serious adverse events. Also, it did not result in any adverse hematological events nor in the formation of any abnormal or ectopic tissue. No safety concerns were observed in the long term 5-year safety follow-up.

        In stem cell studies requiring patient-reported outcomes, such as our Chondrogen studies, high placebo rates have been observed. We have seen similar effects in our Crohn's disease studies. We continue to evaluate ways to overcome or compensate for this elevated placebo rate. We will initiate

12


Table of Contents

our next clinical trials in this field when and if better techniques or outcomes are available to control for the placebo effect.

Scientific Background

        Stem cells are a special class of cells that can self-replicate and differentiate into multiple tissue types. Different populations of stem cells, also called progenitor or precursor cells, reside within the body. These cells are generally classified according to their differentiation potential, or ability to become distinct cell types. Embryonic stem cells ("ESCs") are recognized as being totipotent, or unlimited, in terms of the number of different cell types they can become. Other stem cells are either multipotent, meaning capable of becoming two or more cell types, or unipotent, meaning preprogrammed for a single final cell type. Multipotent stem cells include the hematopoietic stem cells ("HSCs") responsible for generating cells associated with the circulatory and immune systems, MSCs responsible for the formation of connective tissue cells, and neuronal stem cells dedicated to producing the different nervous system cell types. Stem cells participate in embryological and fetal development and orchestrate tissue repair following disease or injury in the adult. Though the precise mechanism of their activity has not yet been determined, experimental work has provided empirical evidence of the therapeutic benefit of various types of stem cells administered to animal and human subjects.

        The ESC has the greatest differentiation potential and is capable of developing into all cell types found within the human body. ESCs must be harvested from human embryos, giving rise to ethical controversies surrounding the procurement of ESCs, which have hindered progress in ESC research. Also, technical difficulties in purifying and growing ESCs and safety concerns have prevented widespread clinical evaluation.

        In adults, two major classes of stem cells exist in bone marrow: HSCs and MSCs. Throughout life, HSCs, located within the bone marrow give rise to most types of blood cells. HSC transplantation has served as the basis for a number of aggressive treatments for various types of cancer. However, therapies based on HSCs are largely limited to hematological disorders because HSCs can only differentiate into blood cells.

        In contrast to HSCs, MSCs are progenitor cells that differentiate into various connective tissues, such as bone, muscle, fat, tendon, ligament, cartilage and bone marrow stroma when they receive appropriate biochemical and biomechanical signals. Other biochemical stimuli cause MSCs to mobilize to areas of injury or inflammatory disease. Once there, MSCs coordinate tissue regeneration at a local level by producing tissue growth factors and by interacting with local cells to reduce inflammation and scarring. Importantly, MSCs do not express certain markers on the surface of cells, known as HLA class II antigens, which are responsible for recognition of the cells by the immune system. Also, the cell surface markers, CD40, CD80 and CD86, which are essential for activation of immune cells, are not present on MSCs. These characteristics allow MSCs to:

    be transplanted into an unmatched patient without giving rise to an immune response;

    regenerate connective tissues like bone and cartilage;

    act as a potent anti-inflammatory agent; and

    exhibit anti-fibrotic activity to limit tissue damage.

        MSCs and HSCs are most readily isolated from bone marrow. Because MSCs represent a small fraction of bone marrow cells, they require amplification to be clinically useful. We have developed and optimized a proprietary process for isolating and expanding these cells using standardized cell culture methodologies. We can grow MSCs in a controlled fashion to produce up to 10,000 treatments of our biologic drug candidates from a single bone marrow donation.

13


Table of Contents

        Stem cells can be derived from either the patient, referred to as an autologous source, or from a donor, referred to as an allogeneic source. For many cell therapies, allogeneic sourcing is not possible due to the immune response that typically occurs following the injection of unrelated cells. The non-immunogenic nature of MSCs permits allogeneic cell sourcing and carries significant advantages over autologous sourcing. Allogeneic cell sourcing from a healthy donor population allows for specific quality control measures to select therapeutically optimal stem cells. For example, if a patient's cells are of poor quality due to advanced age, disease or metabolic state, the resulting product will likely be of similarly poor quality. We believe that allogeneic sources used in large scale production will enable us to utilize quality control practices to ensure that product potency is reproducible from treatment to treatment. We have developed quality standards for our biologic drug candidates, including potency assays relevant to the specific indication.

Strategy

        We are the first company to receive marketing approval of a stem cell drug and strive to become the world's leading provider of stem cell therapies.

        Promote market acceptance and share of Grafix and Ovation and expand our pipeline of other Biosurgery products.    We intend to continue to promote our Biosurgery products through marketing and distribution efforts, and to conduct clinical trials necessary to procure third party reimbursement for outpatient procedures using these products. We also intend to identify new Biosurgery products or additional applications for our current products.

        Successfully commercialize our lead stem cell therapy, Prochymal.    We completed enrollment of the first worldwide Phase 3 stem cell clinical trial in the fourth quarter of 2008, enrolling 244 patients at 72 leading bone marrow transplant centers across the United States, Canada, United Kingdom, Spain, Italy, Australia, Germany and Switzerland, for the treatment of steroid refractory GvHD with Prochymal. Although Prochymal approached but did not reach statistical significance in this trial, its results were nevertheless significant in our successful efforts to obtain marketing approval for Prochymal for the treatment of steroid refractory acute GvHD in pediatric patients, in Canada and New Zealand. We plan to launch Prochymal for these limited indications in these jurisdictions. In addition, we continue to evaluate the prospects of obtaining marketing approval for Prochymal in other jurisdictions, including the United States. We plan to develop a sales and marketing organization to promote Prochymal, initially for the treatment of the orphan indication of refractory GvHD in Canada and New Zealand, and if we pursue and obtain marketing approval elsewhere, to expand our marketing efforts accordingly. Based on the small number of hospitals performing bone marrow transplants and treating patients with GvHD and the lack of effective treatments for this population, we believe that, if and when more widely approved, we can successfully market Prochymal with a small, highly trained sales force

        Expand our pipeline of biologic drug candidates where our stem cell technology has a therapeutic potential.    We are continuously investing in our biologic drug candidate pipeline by evaluating our therapies in additional diseases and disorders where we believe MSCs may have therapeutic benefit. This will allow us to maintain our position as a leader in cellular therapeutics.

        Exploit our MSC technology, manufacturing ability and proprietary know-how to advance our pipeline.    We intend to leverage our preclinical research, safety data and manufacturing ability to grow our biologic drug candidate pipeline. Because we utilize MSCs as the active agent for all of our biologic drug candidates, we believe the accumulated safety data will reduce the time and cost associated with early stage clinical trials for new indications.

        Internally develop and commercialize future biologic drug candidates and novel tissue products.    We believe that we have the requisite experience to develop and commercialize any future biologic drug

14


Table of Contents

candidates without the help of a strategic partner if necessary or determine it to be the preferred strategy. Due to our experience with Osteocel and our current pipeline candidates, we believe we have gained the clinical, regulatory, manufacturing and commercial capabilities to successfully develop and commercialize biologic drug candidates and novel tissue products.

Collaborations

Genzyme Corporation—Collaboration Agreements

Prochymal and Chondrogen Development and Commercialization

        In October 2008, we entered into a collaboration agreement with Genzyme Corporation, then an independent and now a Sanofi company, for the development and commercialization of Prochymal and Chondrogen. Under the terms of the agreement, we retained the right to commercialize Prochymal and Chondrogen in the United States and Canada, and Genzyme was provided the exclusive right to commercialize the treatments in all other countries, except with respect to GvHD in Japan where JCR Pharmaceuticals Co., Ltd. has these rights.

        The Collaboration Agreement also provided for upfront non-contingent, non-refundable payments to us of $130.0 million ($75.0 million of which was received in November 2008 and $55.0 million of which was received in July 2009).

        In February 2012, Sanofi issued a press release which included an update on their R&D pipeline, stating that it had discontinued its project with Prochymal for GvHD. In September 2012, we reached agreement with Sanofi to conclude the Collaboration Agreement without either party having any continuing obligation to the other. We are continuing to proceed with our Prochymal regulatory approval and commercialization efforts.

Prochymal Development to Treat Acute Radiation Syndrome

        In July 2007, we entered into an agreement with Genzyme for collaboration in the preparation and execution of development and purchase agreements with United States and Allied government agencies for countermeasures to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from DoD for the development and stockpiling of Prochymal for the treatment of ARS. During the three years ended December 31, 2010, DoD has paid us $6.0 million in connection with this contract. We are not presently performing any work under the DoD contract, nor are we pursuing any other government contracts in partnership with Genzyme. Our agreement with Genzyme expired in July 2010.

Juvenile Diabetes Research Foundation—Collaborative Agreement

        In October 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation for the development of Prochymal as a treatment for the preservation of insulin production in patients with newly diagnosed type 1 diabetes. Under the terms of the agreement, JDRF has agreed to fund $4.0 million of the research costs, payable to us based upon the achievement of established milestones. We received $1.5 million in funding from JDRF during 2009, $2.0 million in funding from JDRF during 2008, and the remaining $500,000 in funding during 2010. We recognized revenue from the JDRF agreement over the term of our obligations under this agreement, concluding in fiscal 2011.

JCR Pharmaceuticals Co., Ltd.—License Agreement

        In August 2003, we entered into a license agreement with JCR Pharmaceuticals Co., Ltd., pursuant to which we granted to JCR an exclusive right in Japan to our MSC technology for use in connection with the use of hematopoietic stem cells derived from peripheral blood, cord blood or bone marrow in the treatment of hematological malignancies.

15


Table of Contents

        The license agreement provided for a payment by JCR to us of an up-front license fee of $3.0 million and payment of an additional $0.5 million upon a certain technology transfer. We received a $0.5 million milestone payment in 2007 when JCR filed an Investigational New Drug ("IND") application in Japan. We also received a $1.0 million milestone payment in the first quarter of 2010 when JCR commenced a pivotal trial in Japan. In addition, if and when marketing approval is obtained in Japan, JCR is required to pay up to $5.5 million in additional pre-commercialization milestones per product and certain amounts for pre-determined thresholds of cumulative net sales. Lastly, JCR has an obligation to pay royalties to us, with such amount dependent upon the cumulative net sales.

        Under the terms of the collaborative arrangement, JCR bears all costs associated with bringing the drug to market in Japan. JCR is obligated to use its reasonable best efforts to develop and commercialize in Japan products covered under the terms of the license, including conducting clinical trials and procuring regulatory and other approvals. The license expires with respect to specific products on the later of 15 years from the date of the first sale of the product in Japan or the date on which our last patent in Japan covering that product expires. Also, the license and the collaboration can be terminated unilaterally by JCR upon 180 days notice to us or by mutual agreement between us and JCR.

        In conjunction with this collaboration, JCR made a $3.0 million investment in our preferred stock, which converted at the closing of our initial public offering into 136,363 shares of our common stock.

Intellectual Property

        Our broad intellectual property portfolio originates from our pioneering scientific efforts. We have established a considerable patent position in adult stem cell technology and actively seek to protect proprietary technologies that we consider important to our business, including compositions of matter as well as methods of manufacture and methods of use. We believe that one particularly strong aspect of our patent estate is a claim that relates to the isolated mesenchymal stem cell regardless of its origin, type of expansion or ultimate use. Other layers of our patent protection relate to the application of our stem cell technologies to various organs (e.g. heart, lungs) and therapeutic areas (e.g. autoimmune disorders, inflammatory disorders) among others. Additionally, we own intellectual property ("IP") related to purified compositions of MSCs and the methods that we believe are necessary to manufacture a safe product. We currently own or have exclusive licenses to 50 issued U.S. patents. Foreign counterparts to these patents, including composition of matter claims, have been granted, and we own or hold licenses to 156 issued patents in Europe, Canada, Australia and other countries. The patents and patent licenses included in our portfolio address, among other things, composition of matter, methods of use, and methods of manufacture of mesenchymal stem cells. We aggressively pursue our patent portfolio, and have 31 additional U.S. patent applications and 76 foreign patent applications pending. We are also committed to protecting our intellectual property position by continuously monitoring the competitive landscape and are prepared to act aggressively in the event that our market position is threatened by an infringing product.

        For most of our biologic drug candidates, we rely on multiple patents in combination. The following provides a description of some of our key patents and is not intended to represent an assessment of claims limitations or scope. Each of the following patents is assigned to Osiris or licensed with a conveyance of all substantial rights as described below. For the issued U.S. patents referred to

16


Table of Contents

below, there are corresponding applications that allow us to pursue patents in other countries, some of which have been issued. These foreign patents have expiration dates ranging from 2013 to 2019.

Patent
  Jurisdiction   Subject Matter   Related Product(s)   Expiry*  

5733542

  United States   Enhancing bone marrow engraftment using MSCs.   Prochymal     2015  

5811094

 

United States

 

Therapeutic use of MSCs for the repair of connective tissue.

 

Prochymal, Chondrogen

   
2015
 

6328960

 

United States

 

Use of MSCs in transplantation, e.g. marrow, tissues and organs.

 

Prochymal

   
2019
 

6355239

 

United States

 

Basis for universal use of MSCs without recipient matching.

 

Prochymal, Chondrogen

   
2018
 

6368636

 

United States

 

MSCs for prevention and treatment of immune responses in transplantation.

 

Prochymal

   
2019
 

6387369

 

United States

 

Use of MSCs for cardiac muscle repair.

 

Prochymal

   
2020
 

7029666

 

United States

 

Uses for human mesenchymal stem cells

 

Prochymal

   
2018
 

7892829

 

United States

 

Cardiac muscle regeneration using mesenchymal stem cells

 

Prochymal

   
2018
 

*
All noted expiry dates are based on filing dates; actual expiry depends on a number of factors and may vary.

        Patent life determination depends on the date of filing of the application and other factors promulgated under patent law and regulatory laws including, for example, the United States Drug Price Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Act. The patent term restoration period is generally one-half the time between the effective date of an Investigational New Drug Application or IND and the submission date of a New Drug Application ("NDA") or Biologics License Application ("BLA"), plus the time between the submission date of an NDA or BLA and the approval of the drug. Only the earliest patent applicable to an approved drug is eligible for the extension. The United States Patent and Trademark Office, in consultation with the FDA, reviews and approves applications for patent term extension. Where appropriate and when eligible, we expect to apply for patent term extensions in an effort to bolster market exclusivity beyond nominal patent expiration dates.

        We also rely upon trade secrets to protect our proprietary information. A significant amount of our technology, including our teaching regarding the manufacturing processes of our Biosurgery products, is unpatented and is maintained by us as trade secrets. Through our experience with MSCs and MSC-based product development, we have developed expertise and know-how in this field. We have the capability to manufacture clinical grade MSCs in-house. We also contract for the production through contract manufacturers. To protect this know-how, our policies require confidentiality agreements with our employees, consultants, contractors, manufacturers, outside collaborators, sponsored researchers, and advisors. These agreements generally provide for protection of confidential information, restrictions on the use of materials and assignment of inventions conceived during the course of performance for us. These agreements might not effectively prevent disclosure of our confidential information.

17


Table of Contents

        We were founded on the basis of MSC technology obtained from Case Western Reserve University ("CWRU"). In January 1993, we entered into a Technology Transfer and License Agreement with CWRU, which was subsequently amended in October 1999 and twice in October 2003. Pursuant to this license agreement, certain patents were assigned to us and others were exclusively licensed to us, with the right to grant sublicenses. The exclusive license is subject to any rights of a governmental agency based on research funding by such an agency, and to CWRU's retained rights under the patents for non-clinical research, testing or educational purposes of CWRU.

        With respect to the patents licensed to us by CWRU, we are obligated to pay royalties to CWRU based on sales of products covered by granted licensed patents, and such royalties commence with respect to each such product on the third anniversary of the initial sale thereof. We are also obligated to pay minimum royalties under the agreement with CWRU and remain responsible for patent costs. The license is terminable by CWRU in the event that there is a material breach by us. Otherwise the license is for the life of the patents. Under certain circumstances, we are obligated to negotiate in good faith with a third party a sublicense under patents licensed from CWRU and under patents and know-how owned by us that are reasonably required by the third party to exercise the granted sublicense. We are not obligated to grant such a sublicense where it would have a potential adverse effect on a product being researched, developed or commercialized by us or by a licensee or sublicensee of ours.

Manufacturing

Production of Grafix and Ovation

        Grafix and Ovation are novel cellular repair matrices derived from human placental tissue, and provide the essential components needed for repair and regeneration—extracellular matrix, viable endogenous MSCs and a replenishing source of growth factors—without the need for autografting. Unlike our biologic drug candidates, the stem cells and cellular matrix used in Grafix and Ovation are obtained from tissue donors. Additionally, the production of our Biosurgery products differs from the production of our biologic drug candidates in numerous other ways, including that the cells are not expanded.

        We contract with tissue recovery agencies for our Biosurgery products source tissue. Once an initial qualification of the donor is performed the tissue is sent to our processing center overnight. The agencies also compile the donor medical records, collect medical and social history, and collect samples for serological testing. These agencies operate on a fee for service basis. We intend to enter into contracts with additional tissue recovery agencies in the future in order to fulfill expected product demand.

        The processing of our Biosurgery products is in many ways more like the process of organ donation than standard tissue processing. This is because it is essential that the stem cells contained within these products are kept in a living, healthy state. We overcome this challenge through a proprietary process that is designed to maintain the integrity of the material, particularly the stem cells. Following completion of this process as well as quality control testing and quality assurance review, the Biosurgery product is released for distribution.

Production of Biologic Drug Candidates

        One way in which we believe that we have differentiated ourselves from other stem cell companies is through proprietary manufacturing methods that allow for the controlled growth of MSCs to produce up to 10,000 treatments of our biologic drug candidates from a single bone marrow donation. This is in contrast to many other stem cell technologies that are able to make only a single treatment from each donation.

18


Table of Contents

        We have been manufacturing MSCs for almost fifteen years. The first material manufactured in-house was released in 1999. Since that time manufacturing has continued to expand to support our clinical trials. The current manufacturing process utilizes cell factories, a closed system of surfaces on which the cells adhere, for stem cell expansion. We have developed this technology into a reproducible process that can be scaled up and transferred to additional sites. A second manufacturing site was successfully qualified in 2003. In addition, JCR Pharmaceuticals, our partner in Japan, has successfully implemented our manufacturing technology in Japan. We and our contract manufacturers believe that we perform all of our manufacturing activities in compliance with the FDA's current Good Manufacturing Practice requirements.

        Our manufacturing process begins with the collection of bone marrow aspirate from qualified volunteer donors, 18-30 years of age. Prior to donation, these individuals are screened and tested for a battery of diseases including HIV and hepatitis according to the FDA's donor suitability guidance. We purchase bone marrow aspirate from commercial sources. Since the MSC is extremely rare, accounting for only one in every 100,000 cells in bone marrow, an initial purification process is required. Upon arrival at our facilities, MSCs are isolated and selectively removed from the bone marrow through a multi-step process. A beneficial feature of our stem cells is that they adhere to the surface of the cell factory and the other remaining cell populations that do not adhere are removed in processing. Our stem cells are then expanded, harvested, packaged and cryopreserved as an in-process intermediate, and we conduct a second battery of quality testing. Each packaged intermediate is further expanded and formulated to produce the final product. Sterility and other extensive quality testing completes the process. This well-defined process has allowed for the development of a supply chain where material specifications have been established and vendors have been qualified.

        The final product has been configured to allow for ease of storage, distribution and use in the clinic. We ultimately expect the product will be provided in ready-to-use patient dose quantities, shipped frozen from the distribution center, and stored in the freezer at the clinic or hospital.

Sales, Marketing and Distribution

Biosurgery Products

        We currently intend to continue to self-commercialize all of our Biosurgery products through the efforts of focused direct distribution and marketing staff, and through a growing network of distributors. Our marketing of Grafix is targeted at facilities caring for burn and chronic wound patients in the United States. The most rapid adoption for Grafix has been for the treatment of burns and severe wounds in an inpatient hospital environment. As discussed above, we have received transitional and permanent pass-through status from the CMS, with C-Codes and Q-codes for Grafix, which will assist in facilitating reimbursement in the physician office setting, offering additional access for Medicare patients.

        A study designed to further facilitate health care reimbursement began during the second fiscal quarter of 2012. This is a multicenter, adaptive design, randomized study to evaluate the efficacy and safety of Grafix for the treatment of chronic diabetic foot ulcers. Up to 266 patients will be enrolled in this study and will receive either Grafix or a control dressing for a chronic diabetic foot ulcer that is between 1 cm2 and 15 cm2. Patients are randomized in a 1:1 ratio. The primary efficacy endpoint of this study is complete wound closure, defined as 100% re-epithelialization, by week 12. Additional secondary efficacy endpoints include time to initial wound closure, number of patients with at least 50% reduction in wound size by Day 28 and number of applications of Grafix versus control. This trial is conducted at 20 wound care clinics across the US and is currently enrolling patients.

        We anticipate that Grafix will become more widely adopted for treatment of chronic wounds, including diabetic foot ulcers with the assignment of reimbursement codes.

19


Table of Contents

        Our marketing of Ovation is targeted to orthopedic surgeons and neurosurgeons practicing in the United States. We may enter into strategic partnerships with device or other orthopedic distributors to facilitate distribution.

Therapeutic Drug Candidates

        We currently intend to self-commercialize all of our biologic drug candidates upon regulatory agency approval through the creation of sales and marketing capabilities in existing and new indications. We have also entered into a collaborative arrangement with JCR Pharmaceuticals Co., Ltd. for the distribution of Prochymal for GvHD in Japan following marketing approval.

        Our biologic drug candidates are stored at -135 degrees Celsius or lower. Generally, we do not believe this will pose a significant problem for end-users as most sophisticated hospitals and medical centers have freezers with these storage capabilities readily available. However, some facilities may not have this type of storage available and this may limit distribution. In an effort to mitigate this, we are performing studies to store the product at higher temperatures.

Competition

        Our industry is subject to rapid and intense technological change. We face, and will continue to face, intense competition from pharmaceutical, biopharmaceutical and biotechnology companies, as well as numerous academic and research institutions and governmental agencies engaged in drug discovery activities or funding, both in the United States and abroad. Some of these competitors are pursuing the development of drugs and other therapies that target the same diseases and conditions that we target in our commercial, clinical and preclinical programs.

        Many of the companies competing against us have financial and other resources substantially greater than our own. In addition, many of our competitors have significantly greater experience in testing pharmaceutical and other therapeutic products, obtaining regulatory approvals of products, and marketing and selling those products. Accordingly, our competitors may succeed in more rapidly obtaining approval for products and achieving widespread market acceptance. If we obtain necessary regulatory approval and commence significant commercial distribution of our products, we will also be competing with respect to manufacturing efficiency and marketing capabilities, areas in which we have limited commercial-scale experience.

        Our Biosurgery segment competes with other companies and organizations that are marketing products competitive with Grafix and Ovation, including Advanced Biohealing, the manufacturer of Dermagraft which competes with Grafix; Organogenesis, the manufacturer of Apligraf, which competes with Grafix; and surgical autograft procedures. In addition to those listed, there are other potential competitors developing a variety of competing products. The limited patent protection for our Biosurgery products reduced the barrier for entry by others and makes these products susceptible to increased risk of competition.

        Once more widely approved and launched for commercial sale, Prochymal will compete, and if approved for commercial sale, Chondrogen would compete with marketed products and other future biologic drug candidates. The primary competitors include:

    Prochymal.  Although not yet launched commercially, and with approval limited to pediatric applications in Canada and New Zealand, Prochymal is the first drug indicated for the treatment of acute GvHD. Prochymal will compete with steroids and other traditional off label therapies for GvHD.The competitive landscape in Crohn's disease is more crowded and, if approved, Prochymal will compete with Johnson & Johnson's Remicade®, Abbott's HUMIRA®, Biogen's Tysabri® and UCB's Cimzia®.

20


Table of Contents

    Chondrogen.  If approved, Chondrogen will compete with pain relievers such as acetaminophen, nonsteroidal anti-inflammatory drugs and intra-articular injection of corticosteroid or hyaluronic acid. However, none of these pain relievers have proven disease modification, which is one of the goals of the Chondrogen development program.

        We may face competition in the future from other companies that are researching and developing stem cell therapies. We are aware of many companies working in this area, including: Aastrom Biosciences, Advanced Cell Technology, Aldagen, Inc., Athersys, Cellerant Therapeutics, Cellerix SA, Cognate Therapeutics, Cytori Therapeutics, Gamida Cell, Mesoblast, MultiCell Technologies, Theradigm, Pluristem Therapeutics, Inc. and StemCells.

        We expect to compete based upon, among other things, our intellectual property portfolio and the efficacy of our products. Our ability to compete successfully will depend on our continued ability to attract and retain skilled and experienced scientific, clinical development and executive personnel, to identify and develop viable biologic drug candidates and to exploit these products and compounds commercially before others are able to develop competitive products.

        In addition, our stem cell therapies may be expensive as compared to other therapies and this may make it more difficult for such therapies to compete with other pharmaceuticals.

Government Regulation

        Regulation by governmental authorities in the United States and other countries is a significant factor in the development, manufacture, commercialization and reimbursement of our products and services. Certain products we develop will require marketing approval, or licensure, by governmental agencies prior to commercialization. In particular, human therapeutic products are subject to rigorous preclinical and clinical testing and other approval procedures of the U.S. Food and Drug Administration, or FDA, and similar regulatory authorities in other countries. Various governmental statutes and regulations also govern or influence testing, manufacturing, safety, labeling, storage and record keeping related to such products and their marketing. State, local and other authorities may also regulate pharmaceutical manufacturing facilities. The process of obtaining these approvals and the subsequent compliance with appropriate statutes and regulations require the expenditure of substantial time and money, and there can be no guarantee that approvals will be granted.

Human Cellular and Tissue-Based Product

        Human cells or tissue intended for implantation, transplantation, infusion, or transfer into a human recipient is regulated by the FDA as human cells, tissues, and cellular and tissue-based product, or HCT/Ps. Our Biosurgery products are regulated as 361 HCT/Ps and not as biologics or drugs. HCT/Ps are regulated differently from drug or biologic products due to the fact they are minimally manipulated tissues intended for homologous use in the patient's body, are not combined with a drug, device or biologic, and do not have systemic or metabolic effects on the body. The FDA does not require premarket approval for HCT/Ps, however, it does require strict adherence to federally mandated cGTP regulations. These regulations are analogous to the GMP regulations described above in terms of manufacturing standards. In addition, the FDA's regulations include other requirements to prevent the introduction, transmission and spread of communicable disease. The FDA's regulations require tissue establishments to register and list their HCT/Ps with the FDA and to evaluate donors through screening and testing.

        We maintain state licensure as a human tissue bank in Maryland, California, Florida, and New York. These are the only states in which such licensure is required for us.

21


Table of Contents

Regulatory Approval Process

        Our biologic drug candidates will require approval from the FDA and corresponding agencies in other countries before they can be marketed. The FDA regulates human therapeutic products in one of three broad categories: biologics, drugs, or medical devices. Our biologic drug candidates will be regulated as biological products. The FDA generally requires the following steps for pre-market approval or licensure of a new biological product or new drug product:

    preclinical laboratory and animal tests conducted in compliance with the FDA's Good Laboratory Practice, or GLP, requirements to assess a drug's biological activity and to identify potential safety problems, and to characterize and document the product's chemistry, manufacturing controls, formulation, and stability;

    submission to the FDA of an IND application or equivalent application in other territories, which must become effective before clinical testing in humans can begin;

    obtaining approval of Institutional Review Boards ("IRBs") of research institutions or other clinical sites to introduce the biologic drug candidate into humans in clinical trials;

    adequate and well-controlled human clinical trials to establish the safety and efficacy of the product for its intended indication conducted in compliance with the FDA's Good Clinical Practice, ("GCP") requirements;

    compliance with current Good Manufacturing Practices ("cGMP") regulations and standards;

    submission of a BLA to the FDA, (or a a NDS to Health Canada, or an equivalent thereof in other territories) for marketing that includes adequate results of preclinical testing and clinical trials;

    review of the marketing application in order to determine, among other things, whether the product is safe, and effective for its intended use; and

    obtaining regulatory approval of the product, including inspection and approval of the product manufacturing facility as compliant with cGMP requirements, prior to any commercial sale of the pharmaceutical agent.

        Typically, clinical testing involves a three-phase process, although the phases may overlap. In Phase 1, clinical trials are conducted with a small number of healthy volunteers or patients and are designed to provide information about product safety and to evaluate the pattern of drug distribution and metabolism within the body. In Phase 2, clinical trials are conducted with groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and expanded evidence of safety. In some cases, an initial trial is conducted in diseased patients to assess both preliminary efficacy and preliminary safety and patterns of drug metabolism and distribution, in which case it is referred to as a Phase 1/2 trial. Phase 3 clinical trials are generally large-scale, multi-center, comparative trials conducted with patients afflicted with a target disease in order to provide statistically valid proof of efficacy, as well as safety and potency. Often an agency will require Phase 4 or post-marketing trials to collect additional data about the drug on the market. During all phases of clinical development, regulatory agencies require extensive monitoring and auditing of all clinical activities, clinical data and clinical trial investigators. An agency may, at its discretion, alter, suspend, or terminate the testing based upon the data which have been accumulated to that point and its assessment of the risk/benefit to the patient.

        Upon review of a BLA or NDS or equivalent, the regulatory authority may grant marketing authorization, request additional clinical data or deny approval if the agency determines that the application does not satisfy its approval criteria. Review of a marketing application typically takes one to three years, but may last longer, especially if the agency asks for more information or clarification of

22


Table of Contents

information already provided. Further clinical trials may be required to gain approval to promote the use of the product for any additional indications. Such additional indications are obtained through the approval of supplemental applications.

        The process of obtaining regulatory approval is lengthy, uncertain, and requires the expenditure of substantial resources. Each NDA or BLA must be accompanied by a user fee, pursuant to the requirements of the Prescription Drug User Fee Act ("PDUFA") and its amendments. PDUFA also imposes an annual product fee for prescription drugs and biologics ($65,030), and an annual establishment fee ($392,700) on facilities used to manufacture prescription drugs and biologics. Fee waivers or reductions are available in certain circumstances, including a waiver of the application fee for the first application filed by a small business. Additionally, no user fees are assessed on NDAs or BLAs for products designated solely as orphan drugs. If a contract manufacturer is used, the contract manufacturer is responsible for the establishment fee.

        Before approving a marketing application, all facilities and manufacturing techniques used for the manufacture of products must comply with applicable FDA regulations governing cGMP. In the United States, a local field division of the FDA is responsible for completing this inspection and for providing a recommendation for or against approval. This effort is intended to assure appropriate facility and process design in order to avoid potentially lengthy delays in product approvals due to inspection deficiencies. Similarly, before approving a new drug or biologics application, the FDA may also conduct pre-licensing inspection of a company, its contract research organizations and/or its clinical trial sites to ensure that clinical, safety, quality control and other regulated activities are compliant with GCP. To assure such cGMP and GCP compliance, the applicants must incur significant time and cost and put forth significant effort in the areas of training, record keeping, production, and quality control. Following approval, the manufacture, holding, and distribution of a product requires the continued allocation of significant resources to maintain full compliance in these areas.

        After regulatory approval has been obtained, the agency will typically require post-marketing reporting to monitor potential side effects of the drug. Further studies may be required to provide additional data on the product's risks, benefits, and optimal use, and will be required to gain approval for the use of the product as a treatment for clinical indications other than those for which the product was initially tested. Results of post-marketing programs may limit or expand the further marketing of the product. Further, if there are any modifications to the drug, including changes in indication, labeling, or a change in the manufacturing process or manufacturing facility, a supplement may be required.

        Additionally, once a drug product has been authorized to enter commercial distribution, numerous additional regulatory requirements apply. These include, among others, cGMPs; labeling regulations; the FDA's general prohibition against promoting drug products for unapproved or off-label uses; and adverse event reporting regulations, which require that manufacturers report if their drug may have caused or contributed to a death or serious injury. The FDA has broad post-market and regulatory and enforcement powers. Failure to comply with the applicable U.S. drug regulatory requirements could result in, among other things, warning letters, fines, injunctions, consent decrees, civil penalties, refunds, recalls or seizures of products (which would result in the cessation or reduction of production volume), total or partial suspension of production, withdrawals or suspensions of current product applications, and criminal prosecution. Adverse drug reactions related to a drug product in any existing or future markets could cause regulatory authorities to withdraw market approval for such product.

Fast Track and Orphan Drug Designations

        Congress enacted the Food and Drug Administration Modernization Act of 1997 in part to ensure the availability of safe and effective drugs, biologics, and medical devices by expediting the FDA review process for new products. The Modernization Act establishes a statutory program for the approval of

23


Table of Contents

Fast Track products, including biologics. A Fast Track product is defined as a new drug or biologic intended for the treatment of a serious or life-threatening condition that demonstrates the potential to address unmet medical needs for this condition. Under the Fast Track program, the sponsor of a new drug or biologic may request the FDA to designate the drug or biologic as a Fast Track product at any time during the clinical development of the product. This designation assures access to FDA personnel for consultation throughout the development process and provides an opportunity to request priority review of a marketing application providing an expedited six-month review timeline. During the first quarter of 2005, the FDA designated Prochymal as a Fast Track product for the treatment of GvHD. Prochymal also received Fast Track designation from the FDA in January 2007 for the treatment of refractory Crohn's disease. We cannot predict whether this designation will impact the timing or likelihood of FDA approval of Prochymal.

        The Orphan Drug Act provides incentives to manufacturers to develop and market drugs for rare diseases and conditions affecting fewer than 200,000 persons in the United States at the time of application for Orphan Drug designation. The first developer to receive FDA marketing approval for an Orphan Drug is entitled to a seven year exclusive marketing period in the United States for that product as well as a waiver of the BLA user fee. However, a drug that the FDA considers to be clinically superior to, or different from, another approved orphan drug, even though for the same indication, may also obtain approval in the United States during the seven year exclusive marketing period. The FDA granted Orphan Drug designation for Prochymal for GvHD during the last quarter of 2005, and for type 1 diabetes during the second quarter of 2010.

        Legislation similar to the Orphan Drug Act has been enacted in countries other than the United States, including the European Union. The orphan legislation in the European Union is available for therapies addressing conditions that affect five or fewer out of 10,000 persons. The marketing exclusivity period is for ten years, although that period can be reduced to six years if, at the end of the fifth year, available evidence establishes that the product is sufficiently profitable not to justify maintenance of market exclusivity.

Privacy Law

        Federal and state laws govern our ability to obtain and, in some cases, to use and disclose data we need to conduct research activities. Through the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") Congress required the Department of Health and Human Services to issue a series of regulations establishing standards for the electronic transmission of certain health information. Among these regulations were standards for the privacy of individually identifiable health information. Most health care providers were required to comply with the Privacy Rule as of April 14, 2003.

        HIPAA does not preempt, or override, state privacy laws that provide even more protection for individuals' health information. These laws' requirements could further complicate our ability to obtain necessary research data from our collaborators. In addition, certain state privacy and genetic testing laws may directly regulate our research activities, affecting the manner in which we use and disclose individuals' health information, potentially increasing our cost of doing business, and exposing us to liability claims. In addition, patients and research collaborators may have contractual rights that further limit our ability to use and disclose individually identifiable health information. Any claims that we have violated individuals' privacy rights or breached our contractual obligations, even if we are not found liable, could be expensive and time-consuming to defend and could result in adverse publicity that could harm our business.

Other Regulations

        In addition to privacy law requirements and regulations enforced by the FDA, we also are subject to various local, state and federal laws and regulations relating to safe working conditions, laboratory

24


Table of Contents

and manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances, including chemicals, micro-organisms and various radioactive compounds used in connection with our research and development activities. These laws include, but are not limited to, the Occupational Safety and Health Act, the Toxic Test Substances Control Act and the Resource Conservation and Recovery Act. Although we believe that our safety procedures for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, we cannot assure you that accidental contamination or injury to employees and third parties from these materials will not occur. We may not have adequate insurance to cover claims arising from our use and disposal of these hazardous substances.

Foreign Regulation

        We expect to have to obtain approval for the manufacturing and marketing of each of our products from regulatory authorities in foreign countries prior to the commencement of marketing of the product in those countries. The approval procedure varies among countries, may involve additional preclinical testing and clinical trials, and the time required may differ from that required for FDA approval. Although there is now a centralized European Union approval mechanism in place, this applies only to certain specific medicinal product categories. Each European country may impose certain of its own procedures and requirements in addition to those requirements set out in the appropriate legislation, many of which could be time-consuming and expensive.

Employees

        As of December 31, 2012, our headcount was 59 full-time and 5 part-time employees. Of this total, 23 were engaged in research and development and clinical trials for our Therapeutics segment, 24 were engaged in research, development and manufacturing activities in our Biosurgery segment, and 17 were engaged in administration, finance, sales and marketing, and facilities. All of our employees have entered into non-disclosure agreements with us regarding our intellectual property, trade secrets and other confidential or proprietary information. None of our employees are represented by a labor union or covered under a collective bargaining agreement, and we have not experienced any work stoppages.

25


Table of Contents

Executive Officers of the Registrant

        Executive officers are appointed annually by the Board of Directors and, subject to the terms of any applicable employment agreement, serve at the discretion of the Board of Directors. Information regarding our executive officers is as follows:

Name
  Age   Position   Other Offices or
Positions Held
During the Past Five Years

C. Randal Mills, Ph.D. 

    41   President and Chief Executive Officer (since July 2004)   Dr. Mills is also a member of the Board of Directors. Prior to joining Osiris, Dr. Mills was an executive officer of RTI Biologics, Inc. (NASDAQ—RTIX). Dr. Mills served in several leadership positions at RTI from its formation in 1998 until 2004, including Vice President of Business Development and Vice President of Operation and R&D, and is credited with several key initiatives, including the development and commercialization of RTI's core technology, BioCleanse®.

Lode Debrabandere, Ph.D. 

   
47
 

Chief Operating Officer (since July 2006)

 

Prior to joining Osiris, Dr. Debrabandere served for over four years with Bristol-Myers Squibb as Vice President for Strategic Marketing for Neuroscience and Infectious Diseases. He led the Neuroscience Unit and was the Global Brand Leader for Abilify™. Previously, Dr. Debrabandere led the Marketing department of UCB Pharma Inc., focusing in the areas of allergy/respiratory (Zyrtec™) and neurology (Keppra™).

Michelle LeRoux Williams, Ph.D. 

   
38
 

Chief Scientific Officer (since May 2007)

 

Dr. Williams joined Osiris in 2001 as the Director of Orthopedics and was responsible for the development of Osteocel from the initial concept through product launch in 2005. Dr. Williams also advanced the Chondrogen program from preclinical testing through the Phase I/II clinical trial. Prior to joining Osiris, Dr. Williams completed an NIH postdoctoral fellowship in tissue engineering at Columbia University, evaluating cellular constructs for the repair and regeneration of cartilage in arthritis patients.

26


Table of Contents

Name
  Age   Position   Other Offices or
Positions Held
During the Past Five Years

Philip R. Jacoby, Jr. 

    60  

Chief Financial Officer, Treasurer and Corporate Secretary (since October 2005)

 

Mr. Jacoby has over 30 years of financial and management experience with public and privately held companies. Mr. Jacoby joined Osiris in April 2005 as our Corporate Controller and principal accounting officer in preparation for our initial public offering. Prior to joining Osiris, Mr. Jacoby was the Vice President and Corporate Controller for FTI Consulting, Inc. (NYSE—FCN) for five years. Upon graduation from the University of Maryland, he spent over eight years with Arthur Andersen & Co.

Available Information

        Our website address is www.osiris.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available on our website free of charge as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission, or SEC. The public may read and copy these materials at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains such reports, proxy and information statements and other information, and the Internet address is http://www.sec.gov. Information contained on our website is not and should not be deemed a part of this annual report or any other report or filing filed with the SEC.

ITEM 1A.    Risk Factors.

Risks Related To Our Business

We have a history of operating losses and may not achieve or sustain profitability.

        Until fiscal 2009, we incurred losses in each year since our inception, and may incur additional losses over the next several years. As of December 31, 2012, we had an accumulated deficit of $243.4 million. These losses resulted principally from costs incurred in our research and development programs and from our general and administrative expenses. These losses, among other things, have had and will continue to have an adverse effect on our stockholders' equity, total assets and working capital.

        We expect to continue to incur significant operating expenses in the foreseeable future as we seek to:

    complete our Phase 3 clinical trials for Prochymal for Crohn's disease;

    complete our Phase 2 clinical trial for Prochymal for cardiac indications, and, if supported by the Phase 2 clinical trial, initiate Phase 3 clinical trials;

    complete our controlled trial with Grafix for diabetic foot ulcers;

27


Table of Contents

    enlarge our work force consistent with expanding our business and operations and distribution of our Biosurgery products and as they are approved for sale, our biological drug candidates;

    maintain, expand and protect our intellectual property portfolio; and

    add operational, financial, accounting, facilities engineering and information systems personnel, consistent with expanding our operations.

        The extent of our future operating losses or profits is highly uncertain, and we may not achieve or sustain profitability. If we are unable to achieve and then maintain profitability, the market value of our common stock will decline and you could lose part or all of your investment.

The current credit and financial market conditions may exacerbate certain risk affecting our business.

        We rely upon third parties for certain aspects of our business, including collaboration partners, wholesale distributors, contract clinical trial providers, contact manufacturers and third-party suppliers. Because of the recent tightening of global credit and the volatility in the financial markets, there may be a delay or disruption in the performance or satisfaction of commitments to us by these third parties, which could adversely affect our business.

If we are not able to recruit and retain qualified management and scientific personnel, we may fail in developing our technologies and biologic drug candidates.

        Our future success depends to a significant extent on the skills, experience and efforts of the principal members of our scientific, management and sales personnel. These members include C. Randal Mills, Ph.D., Michelle L. Williams, Ph.D., Philip R. Jacoby, Jr., and Lode Debrabandere Ph.D. The loss of any or all of these individuals could harm our business and might significantly delay or prevent the achievement of research, development or business objectives. We have entered into employment agreements with Dr. Mills and Dr. Debrabandere. The existence of an employment agreement does not, however, guarantee retention of these employees, and we may not be able to retain those individuals for the duration of or beyond the end of their respective terms. Except for Dr. Mills and Dr. Debrabandere, none of our employees is employed for a specified term. Competition for personnel is intense. We may be unable to retain our current personnel or attract or integrate other qualified management and scientific personnel in the future.

If the potential of our stem cell therapies to treat diseases is not realized, the value of our technology and our development programs could be significantly reduced.

        We are currently evaluating the potential of our stem cell therapies to treat diseases. We have not yet proven in clinical trials that our stem cell therapies will be a safe and effective treatment for any disease to the satisfaction of a regulatory agency. Our stem cell therapies are susceptible to various risks, including undesirable and unintended side effects, unintended immune system responses, inadequate therapeutic efficacy or other characteristics that may prevent or limit their marketing approval or commercial use. If the potential of our stem cell therapies to treat disease is not realized, the value of our technology and our development programs could be significantly reduced. Because our biologic drug candidates are based on MSCs, any negative developments regarding the therapeutic potential or side effects of MSCs could have a material adverse effect on our business, financial condition and results of operations.

Our product development programs are based on novel technologies and are inherently risky.

        We are subject to the risks of failure inherent in the development of products based on new technologies. The novel nature of our therapeutics creates significant challenges in regards to product development and optimization, manufacturing, government regulation, third-party reimbursement and

28


Table of Contents

market acceptance. For example, the FDA has relatively limited experience with stem cell therapies. None has been approved by the FDA for commercial sale, and the pathway to regulatory approval for our biologic drug candidates may accordingly be more complex and lengthy. Additionally, stem cells are subject to donor-to-donor variability, which can make standardization more difficult. As a result, the development and commercialization pathway for our therapies may be subject to increased uncertainty, as compared to the pathway for new conventional drugs.

There are no approved treatments for some of the disease indications we are pursuing. This could complicate and delay approval of our biologic drug candidates.

        Patients battling GvHD and who, therefore, are candidates for treatment with Prochymal, are typically very ill as a result of an underlying genetic or oncologic condition. Due to the graveness of their underlying disease and the very serious complications and disorders that often accompany acute GvHD, many of these patients will die from causes other than GvHD prior to the completion of the study even if their GvHD responds favorably to treatment with Prochymal.

        There are also no drugs or therapies currently approved with stated indications for the repair of heart muscle following heart attack. As a result, the clinical endpoints for our biologic drug candidate Prochymal for cardiac indications may be difficult to determine. In the case of Prochymal for the treatment of Crohn's disease, there are other products approved for the treatment of this disease, so it is expected that the clinical efficacy endpoints for Prochymal for this indication will be established by comparison with these already approved treatments. In order to obtain regulatory approval for any indication, we will have to demonstrate, among other things, that our biologic drug candidate is safe and effective for that indication. The results of our clinical trials must be statistically significant, meaning that there must be sufficient data to indicate that it is unlikely the outcome occurred by chance. These challenges may prevent us from developing and commercializing products on a timely or profitable basis, or at all.

Our biologic drug candidates and Biosurgery products represent new classes of therapy that the marketplace may not understand or accept.

        The market may not understand or accept our products. We are developing biologic drug candidates and products that represent novel treatments or therapies and will compete with a number of more conventional products and therapies manufactured and marketed by others, including major pharmaceutical companies. The novel nature of our Biosurgery products creates significant challenges in regards to product development and optimization, manufacturing, government regulation, and third-party reimbursement. As a result, the development pathway for our biosurgery products may be subject to increased scrutiny, as compared to the pathway for more conventional products.

        The degree of market acceptance of any of our developed and potential products will depend on a number of factors, including:

    the clinical safety and effectiveness of our products and their perceived advantage over alternative treatment methods;

    our ability to demonstrate that Prochymal can have a clinically significant effect, initially on treatment resistant acute GvHD, and then also the other indications for which we seek approval;

    our ability to differentiate ourselves from the ethical controversies associated with stem cell drug candidates derived from human embryonic tissue;

    our ability to explain clearly and educate others on the use of human placental tissue, to avoid potential confusion with the ethical controversies associated with human fetal tissue;

29


Table of Contents

    ethical controversies that may arise regarding the use of stem cells or human tissue of any kind, including adult stem cells, adult bone marrow and other adult tissues derived from donors in the manufacture and distribution for profit of our products;

    adverse reactions involving our biologic drug candidates, our biosurgery products or the products or product candidates of others that are stem cell based;

    our ability to supply a sufficient amount of our product to meet regular and repeated demand in order to develop a core group of medical professionals familiar with and committed to the use of our products; and

    the cost of our products such as Prochymal and the reimbursement policies of government and third-party payors.

        If the health care community does not accept our potential products for any of the foregoing reasons, or for any other reason, it could affect our sales, having a material adverse effect on our business, financial condition and results of operations.

The successful commercialization of our biologic drug candidates, or any of our other potential stem cell therapeutics, as well as the distribution of our Biosurgery products, will depend on obtaining reimbursement from third-party payors.

        We expect to distribute our biologic drug candidates initially in the Canada and New Zealand for the treatment of acute GvHD in children. We intend to distribute our Biosurgery products initially in the United States. In the United States and elsewhere, the market for any pharmaceutical product is affected by the availability of reimbursement from third-party payors, such as government health administration authorities, private health insurers, health maintenance organizations and pharmacy benefit management companies. Stem cell therapies like Prochymal and Biosurgery products like Grafix and Ovation may have high higher costs or fees associated with them compared with standard pharmaceuticals, due to the higher cost and complexity associated with -their -research, development and production, the small size and large geographic diversity of the target patient population for some indications, and the complexity associated with distribution of stem cell therapies—and biosurgery products—which require special handling, storage and shipment procedures and protocols. This, in turn, may make it more difficult for us to obtain adequate reimbursement from third-party payors, particularly if we cannot demonstrate a favorable cost-benefit relationship. Third-party payors may also deny coverage or offer inadequate levels of reimbursement for our potential products if they determine that the product has not received appropriate clearances from the FDA or other government regulators or is experimental, unnecessary or inappropriate. For example, patients battling GvHD and who, therefore, are candidates for treatment with Prochymal, are typically very ill as a result of an underlying genetic or oncologic condition. Because these patients have a low probability of survival (whether or not their GvHD is successfully treated), third-party payors may resist reimbursing the cost of treatment.

        In the countries of Europe and in some other countries, the pricing of prescription pharmaceutical products and services and the level of government reimbursement are subject to governmental control. In these countries, pricing negotiations with governmental authorities can take six to twelve months or longer after the receipt of marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct one or more clinical trials that compares the cost effectiveness of our products to other available therapies. Conducting one or more clinical trials would be expensive and result in delays in commercialization of our products. Certain countries may not allow the import, sale or use of our products.

        Managing and reducing health care costs has been a general concern of federal and state governments in the United States and of foreign governments. Although we do not believe that any recently enacted or presently proposed legislation should impact our business, we might be subject to

30


Table of Contents

future regulations or other cost-control initiatives that materially restrict the price we receive for our products. In addition, third-party payors are increasingly challenging the price and cost-effectiveness of medical products and services, and many limit reimbursement for newly approved health care products. In particular, third-party payors may limit the indications for which they will reimburse patients who use any products that we may develop. Cost control initiatives could decrease the price for products that we may develop, which would result in lower product revenues to us.

Our dependence upon a limited supply of bone marrow donors and biologics growth media may impact our ability to produce sufficient quantities of our biologic drug candidates as necessary to complete our clinical trials, and if our trials are successful, to meet product demand.

        The population of acceptable bone marrow donors is limited to volunteers between the ages of 18 and 30. In addition, potential donors are prescreened for a variety of health conditions and are only allowed to donate bone marrow a total of six times in their lifetime, limiting the number of donations. The amount of bone marrow donated may be insufficient for us to mass produce our biologic drug candidates. In addition, the expansion of MSCs through our proprietary manufacturing methods utilizes biologic growth media which may be in limited supply. Future government regulation or health concerns may also reduce the number of donors or otherwise limit the amount of bone marrow available to us. We may not be able to secure quantities of bone marrow or biologic growth media sufficient to meet the manufacturing demands.

Our dependence upon human tissue necessary to produce our Biosurgery products may impact our ability to produce these products on a large scale.

        Our Biosurgery products consist of human tissue provided to us from not-for-profit donor procurement agencies. Grafix and Ovation are processed from human placental tissue. While we are not aware of significant supply issues and placental tissue is generally available to us, these organizations may not be able to provide us with sufficient amounts of human tissue to meet the demand, if we are successful in expanding distribution efforts for our Biosurgery products.

Our biologic drug candidates are derived from human bone marrow sources and our Biosurgery products are derived from human tissue and therefore both have the potential for disease transmission.

        The utilization of donated bone marrow and human tissue creates the potential for transmission of communicable disease, including but not limited to human immunodeficiency virus ("HIV") viral hepatitis, syphilis, Creutzfeldt-Jakob disease, or the human form of "mad cow" disease, and other viral, fungal or bacterial pathogens. Although we are required to comply with federal and state regulations intended to prevent communicable disease transmission, and our suppliers of adult human bone and bone marrow are also required to comply with such regulations in connection with their collection, storage and supply to us:

    we or our suppliers may fail to comply with such regulations;

    even with compliance, our products might nevertheless be viewed by the public as being associated with transmission of disease; and

    a patient that contracts an infectious disease might assert that the use of our products resulted in disease transmission, even if the patient became infected through another source.

        Any actual or alleged transmission of communicable disease could result in patient claims, litigation, distraction of management's attention and potentially increased expenses. Further, any failure in screening, whether by us or other manufacturers of similar products, could adversely affect our reputation, the support we receive from the medical community and overall demand for our products. As a result, such actions or claims, whether or not directed at us, could have a material adverse effect

31


Table of Contents

on our reputation with our customers and our ability to distribute our products, which could have a material adverse effect on our business, financial condition and results of operations.

We may not be able to manufacture our biologic drug candidates in quantities sufficient for later stage clinical studies or for commercial sale.

        We may not be able to produce sufficient quantities of our biologic drug candidates at an acceptable cost. Commercial-scale production of therapies made from live human MSCs involves production in small batches and strict adherence to complex manufacturing and storage protocols and procedures. Our biologic drug candidates are inherently more difficult to manufacture at commercial-scale than chemical pharmaceuticals, which are manufactured using precise chemical formulations and operational methods.

We may not be able to manufacture our Biosurgery products in sufficient quantities to expand our market for the products.

        We may encounter difficulties in the production of our Biosurgery products due to our limited manufacturing capabilities. This difficulty could reduce redistribution efforts of our products, increase our distribution costs or cause production delays, any of which could damage our reputation and effect our operations. Even if we have access to quantities of human tissue sufficient to allow us otherwise to expand our manufacturing capabilities, we may not be able to produce sufficient quantities of the product at an acceptable cost, or at all.

We use third-party collaborators to help us develop and commercialize our products, and our ability to commercialize such products may be impaired or delayed if collaborations are unsuccessful.

        We have arrangements in place with third-party collaborators as a means to help us with research and development efforts or marketing and distribution.

        For example, we have a collaboration with JCR Pharmaceuticals Co., Ltd. granting to JCR an exclusive right to Prochymal for the treatment of GvHD in Japan.

        We are subject to a number of risks associated with our dependence upon our collaborative relationships, including:

    our collaborators may not cooperate with us or perform their obligations under our agreements with them;

    we cannot control the quality, amount and timing of our collaborators' resources that will be devoted to performing their responsibilities under our agreements with them, and our collaborators may choose to pursue alternative technologies in preference to those being developed in collaboration with us;

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

    the right of the collaborator to terminate its collaboration agreement with us for reasons outside our control, and in some cases on limited notice;

    business combinations and changes in a collaborator's business strategy may adversely affect the party's willingness or ability to complete its obligations;

    loss of significant rights to our collaborative parties if we fail to meet our obligations;

    disagreements as to ownership of clinical trial results or regulatory approvals;

32


Table of Contents

    withdrawal of support by a collaborator following development or acquisition by the collaborator of competing products; and

    disagreements with a collaborator regarding the collaboration agreement or ownership of intellectual property or other proprietary rights.

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

We are currently dependent upon third-parties for services and raw materials needed for the manufacture of our biologic drug candidates and our Biosurgery products, and if these are successfully used, may become dependent, or in the case of our Biosurgery products, are dependent, upon third-parties for their distribution. If any of these third parties fail or are unable to perform in a timely manner, our ability to manufacture and deliver could be compromised.

        In order to produce our biologic drug candidates for use in clinical studies, to produce our biosurgery products, and to produce any of our biologic drug candidates that may be approved for commercial sale, we require biological media, reagents and other highly specialized materials. This is in addition to the bone marrow aspirate used in the manufacture of our biologic drug candidates and the human tissue donations used to manufacture our biosurgery products. These items must be manufactured and supplied to us in sufficient quantities and in compliance with cGMP. To meet these requirements, we have entered into supply agreements with firms that manufacture these components to cGMP standards. Our requirements for these items are expected to increase if and when we transition to the manufacture of commercial quantities of our biologic drug candidates.

        In the case of our biologic drug candidates, as we proceed with our clinical trial efforts, we must be able to demonstrate to the FDA that we can manufacture our biologic drug candidates with consistent characteristics. Accordingly, we are materially dependent on these suppliers for supply of cGMP-grade components of consistent quality. Our ability to complete ongoing clinical trials may be negatively affected in the event that we are forced to seek and validate a replacement source for any of these critical components. If we are not able to obtain adequate supplies of these items of consistent quality from our third-party suppliers, it will also be more difficult to manufacture commercial quantities of our biologic drug candidates that are approved for commercial sale.

        We expect to rely on third parties to sell or redistribute both our biologic drug candidates and our Biosurgery products. Proper shipping and distribution requires compliance with specific storage and shipment procedures. Failure to comply with these procedures or the occurrence of inadvertent damage to the shipping container will necessitate return and replacement, potentially resulting in additional cost and causing us to fail to meet supply requirements.

Use of third-party manufacturers may increase the risk that we will not have adequate quantities of our Biosurgery products or our biologic drug candidates.

        Our Biosurgery product supply chain and manufacturing infrastructure depend on the performance of a number of complex contracts between us on the one hand and our suppliers and redistributors on the other. If any of our suppliers, distributors or other business partners cannot or do not perform their contractual obligations, then our production efforts may suffer. If we cannot or do not perform our contractual obligations, then we may be subject to arbitration, mediation or litigation that could have an adverse material effect on us.

33


Table of Contents

        We use third-party manufacturers to supply our biologic drug candidates for clinical trials. Reliance on third-party manufacturers entails risks to which we would not be subject if we manufactured such components ourselves, including:

    reliance on the third party for regulatory compliance and quality assurance;

    the possible breach of the manufacturing agreement by the third party; and

    the possible termination or nonrenewal of the agreement by the third party, based on its own business priorities, at a time that is costly or inconvenient for us.

        Our contract manufacturers are subject to all of the risks and uncertainties that we have when we manufacture on our own. Similar to us, they are subject to ongoing, periodic, unannounced inspection by the FDA and corresponding state and foreign agencies or their designees to ensure strict compliance with cGMP regulations and other governmental regulations and corresponding foreign standards. However, we do not control compliance by our contract manufacturers with these regulations and standards. Our present or future manufacturers might not be able to comply with these regulatory requirements. If our third-party manufacturers fail to comply with applicable regulations, the FDA or other regulatory authorities could impose sanctions on us, including fines, injunctions, civil penalties, denial of marketing approval of our biologic drug candidates, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of biologic drug candidates or our other products, operating restrictions and criminal prosecutions. Any of these actions could significantly and adversely affect supplies of our biologic drug candidates or other products and could have a material adverse effect on our business, financial condition and results of operations.

        We have contracted with Lonza to manufacture quantities of our stem cell drug candidates for our clinical trials. If Lonza is unable to increase production sufficiently, if and when necessary, we may also not be able to meet anticipated market demand in the future.

If our processing and storage facility or our clinical manufacturing facilities are damaged or destroyed, our business and prospects would be negatively affected.

        If our processing and storage facility or the equipment in the facility were to be significantly damaged or destroyed, we could suffer a loss of some or all of the stored units of our biologic drug candidates and it would force us to halt our clinical trial processes.

        We lease approximately 61,203 square feet of space in Columbia, Maryland that houses essentially all of our corporate operations. Currently, we maintain insurance coverage totaling $21.8 million against damage to our property and equipment, an additional $5.0 million to cover business interruption and extra expenses, and $6.0 million to cover R&D restoration expenses. If we have underestimated our insurance needs, we will not have sufficient insurance to cover losses above and beyond the limits on our policies.

Ethical and other concerns surrounding the use of stem cell therapy or human tissue may negatively affect public perception of us or our products or biologic drug candidates, or may negatively affect regulatory approval of our products or biologic drug candidates, thereby reducing demand for our products and adversely affecting the market price for our common stock.

        The commercial success of our biologic drug candidates will depend in part on general public acceptance of the use of stem cell therapy for the prevention or treatment of human diseases. The use of embryonic stem cells and fetal tissue for research and stem cell therapy has been the subject of substantial national and international debate regarding related ethical, legal and social issues. In the U.S., for example, until March 2009, federal government funding of embryonic stem cell research was limited to specifically identified cell lines and was not otherwise available. We do not use embryonic stem cells or fetal tissue, but the public may not be able to, or may fail to, differentiate our use of

34


Table of Contents

adult stem cells from the use by others of embryonic stem cells or fetal tissue. This could result in a negative perception of our company or our products or biologic drug candidates.

        We may obtain stem cells from volunteer adult bone marrow donors from non-profit organizations that collect and process tissue donations. Bone marrow donors receive payment, but ethical concerns have been raised by some about the use of donated human tissue in a for-profit setting

        Future adverse events in the field of stem cell therapy or changes in public policy could also result in greater governmental regulation of our biologic drug candidates and potential regulatory delays relating to their testing or approval.

We will compete with other companies in the marketing and redistribution of our Biosurgery products and we may eventually compete with other companies in the marketing and sale of our biologic drug candidates. Many of these competitors have greater resources or capabilities than we have, or may succeed in developing better products or in developing products more quickly than we do, and we may not compete successfully with them.

        In the marketplace, we compete or may eventually compete with other companies and organizations that are marketing or developing products competitive with Grafix and Ovation and therapies for our targeted disease indications, based on traditional pharmaceutical, medical device or other, non-cellular therapy and technologies. These include for our Biosurgery products: Advanced Biohealing, the manufacturer of Dermagraft which competes with Grafix; Organogenesis, the manufacturer of Apligraf which competes with Grafix. These include for our biologic drug candidates: Novartis, the manufacturer of Neoral® for the prevention of organ rejection in transplant patients, which would compete with Prochymal for the treatment of GvHD; and Johnson & Johnson, the manufacturer of Remicade®, and Abbott, the manufacturer of Humira®, which would compete with Prochymal for the treatment of Crohn's disease. In addition to those listed above, we have other potential competitors developing a variety of therapeutics.

        We also face competition in the cell therapy field from academic institutions and governmental agencies. Many of our current and potential competitors have greater financial and human resources than we have, including more experience in research and development and more established marketing and distribution capabilities.

        We anticipate that competition in our industry will increase. In addition, the health care industry is characterized by rapid technological change, resulting in new product introductions and other technological advancements. Our competitors may develop and market products that render products now or in the future under development by us, or any products manufactured or marketed by us, non-competitive or otherwise obsolete.

The use of our stem cell therapies and Biosurgery products in human subjects may expose us to product liability claims, and we may not be able to obtain adequate insurance.

        We face an inherent risk of product liability claims. None of our products have been widely used over an extended period of time, and therefore our safety data are limited. We derive the raw materials for our products from human donor sources, the manufacturing process is complex, and the handling requirements are specific, all of which increase the likelihood of quality failures and subsequent product liability claims. We will need to increase our insurance coverage when we begin commercial sale of our biologic drug candidates. We may not be able to obtain or maintain product liability insurance on acceptable terms with adequate coverage or at all. If we are unable to obtain insurance, or if claims against us substantially exceed our coverage, then our business could be adversely impacted. Whether or not we are ultimately successful in any product liability litigation, such litigation could

35


Table of Contents

consume substantial amounts of our financial and managerial resources and could result in, among other things:

    significant awards against us;

    substantial litigation costs;

    recall of the product;

    injury to our reputation;

    withdrawal of clinical trial participants; or

    adverse regulatory action.

        Any of these results could have a material adverse effect on our business, financial condition and results of operations.

We will incur additional operating expenses in connection with the expansion of our Biosurgery segment.

        We expect to continue to incur significant operating expenses in connection with our planned expansion of our Biosurgery segment, as we seek to:

    develop our distribution network of professionals for the distribution of Grafix, Ovation and other Biosurgery products;

    hire additional manufacturing, quality control, and quality assurance, and management personnel as necessary to expand our manufacturing operations;

    expand our manufacturing capacity for our Biosurgery products, which will require that we maintain a portion of our space as a Food FDA compliant and validated product manufacturing facility; and

    expand and protect our intellectual property portfolio for our biosurgery products.

        Our redistribution fees from these products have been limited to date. Our ability to scale up our production capabilities for larger quantities of these products remains to be proven. Our costs in marketing and distributing these products will also increase as production increases.

Risks Related to Intellectual Property

If our patent position does not adequately protect our products, others could compete against us more directly, which would harm our business and have a material adverse effect on our financial condition and results of operations.

        Our success depends, in large part, on our ability to obtain and maintain intellectual property protection for our biologic drug candidates and products, and our Biosurgery products. The patent position of biotechnology companies is generally highly uncertain, involves complex legal and factual questions and has been the subject of much litigation. Neither the U.S. Patent and Trademark Office nor the courts has a consistent policy regarding the breadth of claims allowed or the degree of protection afforded under many biotechnology patents.

        The claims of our existing U.S. patents and those that may issue in the future, or those licensed to us, may not confer on us significant commercial protection against competing products. Third parties may challenge, narrow, invalidate, design around, or circumvent any patents owned, assigned or licensed to us and those that we may obtain in the future. Our patents on MSC technology, in particular, cover mesenchymal stem cells and the therapeutic uses thereof. Patents with such claims tend to be more vulnerable to challenge by other parties than patents with extremely narrow claims. Also, our pending patent applications may not issue, may issue with substantially narrower claims than

36


Table of Contents

currently pending claims, or we may not receive any additional patents. Further, the laws of foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Our patents might not contain claims that are sufficiently broad to prevent others from utilizing our technologies. Consequently, our competitors may independently develop competing products that do not infringe our patents or other intellectual property.

        Because of the extensive time required for development, testing and regulatory review of a potential product, it is possible that, before any of our products can be commercialized, any related patent may expire or remain in force for only a short period following commercialization, thereby reducing any advantages of the patent. For instance, one of our patents related to our MSC technology will expire in 2013 if no extensions are applied for and received. To the extent our biologic drug candidates based on that technology are not commercialized ahead of this date, to the extent we have no other patent protection on such products, or to the extent that regulatory or patent extensions are not granted, those products would not have the robust protection we currently expect to enjoy. The background technologies used in the development of our biologic drug candidates are known in the scientific community, and it is possible to duplicate the methods we use to create our biologic drug candidates.

        A significant amount of our technology, including our teaching regarding the manufacturing processes of our Biosurgery products is unpatented and is maintained by us as trade secrets. The limited patent protection for our Biosurgery products reduces the barrier for entry by others and makes these products susceptible to increased competition, which could be harmful to our business.

If certain license agreements are terminated, our market exclusivity could be adversely affected.

        We are a party to various agreements that give us rights to use specified technologies applicable to research, development and commercialization of our product candidates. If these agreements are voided or terminated, our product development, research and commercialization efforts may be altered or delayed. Certain aspects of our technology rely on patented inventions developed using university or other third party resources. The universities or third parties may have certain rights, as defined by law or applicable agreements, in such patents, and may choose to exercise such rights. If we fail to comply with any terms or provisions of these agreements, our rights could be terminated. Currently, we are in compliance with the terms of all agreements, and we do not have any reason to believe that our rights might be terminated.

If we are unable to protect the confidentiality of our proprietary information, trade secrets and know-how, our competitive position would be impaired and our business, financial condition and results of operations could be adversely affected.

        Some aspects of our technology, especially regarding manufacturing processes, are unpatented and maintained by us as trade secrets. A significant amount of our technology, including our teaching regarding the manufacturing processes of our Biosurgery products is unpatented and is maintained by us as trade secrets. In an effort to protect these trade secrets, we require our employees, consultants, collaborators and advisors to execute confidential disclosure agreements before the commencement of their relationships with us. These agreements require that all confidential information developed by the individual or made known to the individual by us during the course of the individual's relationship with us be kept confidential and not disclosed to third parties. These agreements, however, may not provide us with adequate protection against improper use or disclosure of confidential information, and these agreements may be breached. A breach of confidentiality could affect our competitive position. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants, collaborators or advisors have previous employment or consulting relationships. Also, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets.

37


Table of Contents

        Adequate remedies may not exist in the event of unauthorized use or disclosure of our confidential information. The disclosure of our trade secrets would impair our competitive position and could have a material adverse effect on our business, financial condition and results of operations.

If we infringe or are alleged to infringe intellectual property rights of third parties, it will adversely affect our business, financial condition and results of operations.

        Our research, development and commercialization activities, and the manufacture of our biologic drug candidates or products, or the distribution of our Biosurgery products, may infringe or be alleged to infringe patents owned by third parties and to which we do not hold licenses or other rights. There may be applications that have been filed but not published that, when issued, could be asserted against us. These third parties could bring claims against us that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages. Further, if a patent infringement suit were brought against us, we could be enjoined from certain activities including a stop or delay in research, development, manufacturing or sales activities related to the product or biologic drug candidate that is the subject of the suit.

        As a result of patent infringement claims, or in order to avoid potential claims, we may choose or be required to seek a license from the third party. These licenses may not be available on acceptable terms, or at all. Even if we are able to obtain a license, the license would likely obligate us to pay license fees or royalties or both, and the rights granted to us might be nonexclusive, which could result in our competitors gaining access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations, if, as a result of actual or threatened patent infringement claims, we are unable to enter into licenses on acceptable terms. All of the issues described above could also impact our collaborators, which would also impact the success of the collaboration and therefore us.

        There has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the pharmaceutical and biotechnology industries. In addition to infringement claims against us, we may become a party to other patent litigation and other proceedings, including interference and reexamination proceedings declared by the United States Patent and Trademark Office and opposition proceedings before the patent offices for other countries (e.g. the European Patent Office) or similar adversarial proceedings, regarding intellectual property rights with respect to our products and technology. For example, a patent that was granted to us in Europe for human mesenchymal stem cells in the cardiac context was opposed in the European Patent Office by two different companies. In 2008 we prevailed in an opposition before the European Patent Office against one patent related to the cardiac indications of Prochymal. Though we were successful in that particular case, the outcome of any future patent controversies is uncertain. For example, we are currently a party to a patent opposition before the European Patent Office regarding one patent claiming Chondrogen; this process is in an early stage of the opposition proceedings and the ultimate result cannot be predicted at this time with any reasonable degree of certainty. The cost to us of any patent litigation or other proceeding, even if resolved in our favor, could be substantial. Some of our competitors may be able to sustain the costs of such litigation or proceedings more effectively than we can because of their greater financial resources. Patent litigation and other proceedings may also absorb significant management time. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace and, as a result, on our business, financial condition and results of operations. To the extent that our employees, consultants or contractors use intellectual property owned by others, disputes may arise as to the rights related to or resulting from the use of such intellectual property.

38


Table of Contents

We may become involved in lawsuits to protect or enforce our patents or the patents of our collaborators or licensors, which could be expensive and time consuming.

        Litigation may be necessary to enforce patents issued or licensed to us, to protect trade secrets or know-how, or to determine the scope and validity of proprietary rights. Litigation, opposition or interference proceedings could result in substantial additional costs and diversion of management focus. If we are ultimately unable to protect our technology, trade secrets or know-how, we may be unable to operate profitably.

        Competitors may infringe our patents or the patents of our collaborators or licensors. As a result, we may be required to file infringement claims to protect our proprietary rights. This can be expensive, particularly for a company of our size, and time-consuming. In addition, in an infringement proceeding, a court may decide that a patent of ours is invalid or is unenforceable, or may refuse to enjoin the other party from using the technology at issue. An adverse determination of any litigation or defense proceedings could put one or more of our patents at risk of being invalidated or interpreted narrowly. Interference proceedings brought by the U.S. Patent and Trademark Office may be necessary to determine the priority of inventions with respect to our patent applications or those of our collaborators or licensors. Litigation or interference proceedings may fail and, even if successful, may result in substantial costs and distraction to our management. We may not be able, alone or with our collaborators and licensors, to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the United States.

        Furthermore, though we would see protective orders where appropriate, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If investors perceive these results to be negative, the market price for our common stock could be significantly harmed.

        The biotechnology industry, including our fields of therapeutic interest, is highly competitive and subject to significant and rapid technological change. Accordingly, our success will depend, in part, on our ability to respond quickly to such change through the development and introduction of new products. Our ability to compete successfully against currently existing and future alternatives to our product candidates and systems and competitors who compete directly with us in the biopharmaceutical industry will depend, in part, on our ability to: attract and retain skilled scientific and research personnel; develop technologically superior products; develop competitively priced products; obtain patent or other required regulatory approvals for our products; and be early entrants to the market; manufacture, market and sell our products, independently or through collaborations. If a third party were to commercialize a competitive product, there is no assurance that we would have a basis for initiating patent infringement proceedings or that, if initiated, we would prevail in such proceedings.

We are dependent on our intellectual property rights, and if our intellectual property rights do not issue into enforceable patents, are invalidated by third party attack or are circumvented by others' scientific innovation, our business could be seriously affected. As a result, others could compete against us directly, which would harm our business and could have a material adverse effect on our financial condition and results of operations.

        Our success depends, in large part, on our ability to obtain and maintain intellectual property protection for our products. The patent position of biotechnology companies is generally highly uncertain, involves complex legal and factual questions and has been the subject of much litigation. Neither the U.S. Patent and Trademark Office nor the courts has a consistent policy regarding the breadth of claims allowed or the degree of protection afforded under many biotechnology patents.

39


Table of Contents

        The claims of our existing U.S. and foreign patents and those that may issue in the future, or those licensed to us, may not confer on us significant commercial protection against competing products. Third parties may challenge, narrow, invalidate or circumvent any patents we own or may obtain in the future. Our patents on MSC technology, in particular, are quite broad in that they cover mesenchymal stem cells and the therapeutic use thereof. Patents with broad claims tend to be more vulnerable to challenge by other parties than patents with more narrowly written claims. Also, our pending patent applications may not issue, and we may not receive any additional patents. Further, the laws of foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Our patents might not contain claims that are sufficiently broad to prevent others from utilizing our technologies.

        Consequently, our competitors may independently develop competing products that do not infringe our patents or other intellectual property.

Given our patent position in regard to our biosurgey products, if we are unable to protect the confidentiality of our proprietary information and know-how related to these products, our competitive position would be impaired and our business, financial condition and results of operations could be adversely affected.

        A significant amount of our technology, including our teaching regarding the manufacturing processes of our biosurgery products, is unpatented and is maintained by us as trade secrets. In an effort to protect these trade secrets, we require our employees, consultants, collaborators and advisors to execute confidentiality agreements upon the commencement of their relationships with us. These agreements require that all confidential information developed by the individual or made known to the individual by us during the course of the individual's relationship with us be kept confidential and not disclosed to third parties. These agreements, however, may not provide us with adequate protection against improper use or disclosure of confidential information, and these agreements may be breached. For example, a portion of the manufacture of Grafix is protected by trade secrets. A breach of confidentiality could affect our competitive position. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees, consultants, collaborators or advisors have previous employment or consulting relationships. Also, others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets.

        Our biosurgery products are different from our biologic drug candidates in that they do not comprise cultured or manipulated MSCs. Because FDA approval is generally not required for tissue based products like these, competitors might choose to enter this market and produce a substantially similar product whereby we may not be able to prevent the marketing and distribution of any such similar products by others. Should others produce a substantially similar product, we will be subject to increased competition and our potential revenues from redistribution of these biosurgery products may be limited.

        Moreover, like our biologic drug candidates, if our biosurgery products infringe or are alleged to infringe intellectual property rights of third parties, these third parties could bring claims against us that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages. Further, if a patent infringement suit were brought against us, we could be forced to stop or delay research, development, manufacturing or redistribution of the product that is the subject of the suit. Our biosurgery products are subject to many of the same third party infringement risks that our biologic drug candidates are subject to.

        Adequate remedies may not exist in the event of unauthorized use or disclosure of our confidential information. The disclosure of our trade secrets would impair our competitive position and could have a material adverse effect on our business, financial condition and results of operations.

40


Table of Contents

Risks Related to Regulatory Approval and Other Government Regulations

If we are not able to successfully develop and commercialize our biologic drug candidates and obtain the necessary regulatory approvals, we may not generate sufficient revenues to continue our business operations.

        In order to generate sales revenue from our biologic drug candidates, we must conduct extensive preclinical studies and clinical trials to demonstrate that our biologic drug candidates are safe and effective and obtain required regulatory approvals. Our early stage biologic drug candidates may fail to perform as we expect. Moreover, our biologic drug candidates in later stages of development may fail to show the desired safety and efficacy traits despite having progressed successfully through preclinical or initial clinical testing. We will need to devote significant additional research and development, financial resources and personnel to develop commercially viable products and obtain the necessary regulatory approvals.

        If our biologic drug candidates are not deemed safe and efficacious, we will not obtain the required regulatory approvals. If we fail to obtain such approvals, we may not generate sufficient revenues to continue our business operations.

        Any regulatory approval of a product may be subject to limitations on the indicated uses for which it may be marketed. Even after granting regulatory approval, the FDA and regulatory agencies in other countries continue to review and inspect marketed products, manufacturers and manufacturing facilities, which may create additional regulatory burdens. Later discovery of previously unknown problems with a product, manufacturer or facility, may result in restrictions on the product or manufacturer, including a withdrawal of the product from the market. Further, regulatory agencies may establish additional regulations that could prevent or delay regulatory approval of our products.

We cannot market and sell our biologic drug candidates in the United States or in other countries if we fail to obtain the necessary regulatory approvals or licensure.

        We cannot sell our biologic drug candidates until regulatory agencies grant marketing approval, or licensure. The process of obtaining regulatory approval is lengthy, expensive and uncertain. It is likely to take several more years to obtain the required regulatory approvals in the United States for our lead stem cell biologic drug candidate, Prochymal, or we may never gain those approvals. Any difficulties that we encounter in obtaining regulatory approval may have a substantial adverse impact on our operations and cause our stock price to decline significantly. Moreover, because our biologic drug candidates are all based on a single platform technology, MSCs, any adverse events in our clinical trials for one of our biologic drug candidates could negatively impact the clinical trials and approval process for our other biologic drug candidates.

        To obtain marketing approvals in the United States for our biologic drug candidate products, for instance, we must, among other requirements, complete carefully controlled and well-designed clinical trials sufficient to demonstrate to the FDA that the biologic drug candidate is safe and effective for each disease for which we seek approval. Several factors could prevent completion or cause significant delay of these trials, including an inability to enroll the required number of patients or failure to demonstrate adequately that MSCs are safe, effective and potent for use in humans. Negative or inconclusive results from or adverse medical events during a clinical trial could cause the clinical trial to be repeated or a program to be terminated, even if other studies or trials relating to the program are successful. The FDA can place a clinical trial on hold if, among other reasons, it finds that patients enrolled in the trial are or would be exposed to an unreasonable and significant risk of illness or injury. If safety concerns develop, we or the FDA could stop our trials before completion. Some participants in our biologic drug candidate clinical trials have experienced serious adverse events, seven of which have been determined to be possibly related to MSCs and one of which has been determined to be probably related. A serious adverse event is an event that results in significant medical consequences,

41


Table of Contents

such as hospitalization, disability or death, and must be reported to the FDA. We cannot assure you that safety concerns regarding MSCs will not develop.

        The pathway to regulatory approval for biologic drug candidates comprising MSCs may be more complex and lengthy than for approval of a new conventional drug. Similarly, to obtain approval to market our stem cell products outside of the United States, we, together with our collaborative partners, will need to submit clinical data concerning our products and receive regulatory approval from governmental agencies, which in certain countries includes approval of the price we intend to charge for our product. We may encounter delays or rejections if changes occur in regulatory agency policies during the period in which we develop a biologic drug candidate or during the period required for review of any application for regulatory agency approval. If we are not able to obtain regulatory approvals for use of our biologic drug candidates under development, we will not be able to commercialize such products, and therefore may not be able to generate sufficient revenues to support our business.

If we are not able to conduct our clinical trials properly and on schedule, marketing approval by FDA and other regulatory authorities may be delayed or denied.

        The completion of our clinical trials may be delayed or terminated for many reasons, including, but not limited to, if:

    the FDA does not grant permission to proceed and places the trial on clinical hold;

    subjects do not enroll in our trials at the rate we expect;

    subjects experience an unacceptable rate or severity of adverse side effects;

    third-party clinical investigators do not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol, Good Clinical Practice and regulatory requirements, or other third parties do not perform data collection and analysis in a timely or accurate manner;

    inspections of clinical trial sites by the FDA or Institutional Review Boards (IRBs) of research institutions participating in our clinical trials find regulatory violations that require us to undertake corrective action, suspend or terminate one or more sites, or prohibit us from using some or all of the data in support of our marketing applications; or

    one or more IRBs suspends or terminates the trial at an investigational site, precludes enrollment of additional subjects, or withdraws its approval of the trial.

        Our development costs will increase if we have material delays in our clinical trials, or if we are required to modify, suspend, terminate or repeat a clinical trial. If we are unable to conduct our clinical trials properly and on schedule, marketing approval may be delayed or denied by the FDA.

Final marketing approval of our biologic drug candidates by the FDA or other regulatory authorities for commercial use may be delayed, limited, or denied, any of which would adversely affect our ability to generate operating revenues.

        Any of the following factors may cause final marketing approval for our biologic drug candidates to be delayed, limited or denied:

    our biologic drug candidates require significant clinical testing to demonstrate safety and effectiveness before applications for marketing approval can be filed with the FDA;

    data obtained from preclinical and nonclinical animal testing and clinical trials can be interpreted in different ways, and the FDA may not agree with our interpretations;

42


Table of Contents

    it may take many years to complete the testing of our biologic drug candidates, and failure can occur at any stage of the process;

    negative or inconclusive results or adverse side effects during a clinical trial could cause us to delay or terminate development efforts for a biologic drug candidate; or

    commercialization may be delayed if the FDA requires us to expand the size and scope of the clinical trials.

        If marketing approval for our biologic drug candidates is delayed, limited or denied, our ability to market products, and our ability to generate product sales, would be adversely affected.

Producing and marketing an approved drug or other medical product is subject to significant and costly post-approval regulation.

        Even if approved for commercial sale in the United States, it is likely that Prochymal will receive conditional approval by the FDA, and similar to the Health Canada approval for Prochymal for treatment of acute refractory GvHD in children, we will be required to conduct Phase 4 clinical trials to obtain full approval. Even if we obtain full approval by a regulatory agency of a product, that approval is subject to limitations on the indicated uses for which we can market it. After granting marketing approval, regulatory agencies continue to review and inspect marketed products, manufacturers and manufacturing facilities, creating additional regulatory burdens. Later discovery of previously unknown problems with a product, manufacturer or facility may result in restrictions on the product or manufacturer, including a withdrawal of the product from the market. Further, regulatory agencies may establish additional regulations that could prevent or delay marketing approval of our products.

Our business involves the use of hazardous materials that could expose us to environmental and other liability.

        We have facilities in Maryland that are subject to various local, state and federal laws and regulations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals and the use and disposal of hazardous or potentially hazardous substances, including chemicals, micro-organisms and various radioactive compounds used in connection with our research and development activities. In the United States, these laws include the Occupational Safety and Health Act, the Toxic Test Substances Control Act and the Resource Conservation and Recovery Act. We cannot assure you that accidental contamination or injury to our employees and third parties from hazardous materials will not occur. We do not have insurance to cover claims arising from our use and disposal of these hazardous substances other than limited clean-up expense coverage for environmental contamination due to an otherwise insured peril, such as fire.

We may not be able to obtain or maintain Orphan Drug designation for our biologic drug candidates.

        Some jurisdictions, including the European Union and the United States, may designate drugs for relatively small patient populations as orphan drugs. Although the FDA and its European counterpart, the European Medicines Agency, or EMEA, and Health Canada have each designated Prochymal for the treatment of steroid refractory GvHD as an orphan drug, and the FDA has designated Prochymal for the treatment of type 1 diabetes as an orphan drug, none of our other biologic drug candidates have received such designation. Orphan Drug designation does not convey any advantage in, or shorten the duration of, the regulatory review and approval process, but does make the product eligible for orphan drug exclusivity, reduced filing fees and specific tax credits. Generally, if a company receives the first marketing approval for a product with an Orphan Drug designation in the clinical indication for which it has such designation, the product is entitled to orphan drug exclusivity. Orphan drug exclusivity means that the health authorities will not approve another application to market the same

43


Table of Contents

drug for the same indication, except in limited circumstances, for a period of up to seven years in the United States, five years in Canada and ten years in Europe. This exclusivity, however, could block the approval of our biologic drug candidates if a competitor obtains marketing approval before us. Even if we obtain orphan drug exclusivity for any of our biologic drug candidates, we may not be able to maintain it. For example, if a competitive product is shown to be clinically superior to our product, any orphan drug exclusivity we have will not block the approval of such competitive product.

The Fast Track designation for development of any of our products may not lead to a faster development or regulatory review or approval process, and it does not increase the likelihood the biologic drug candidate will receive marketing approval.

        If a drug is intended for the treatment of a serious or life-threatening condition and the drug demonstrates the potential to address unmet medical needs for this condition, the drug sponsor may apply for FDA Fast Track designation for a particular indication. Marketing applications filed by sponsors of products in Fast Track development may qualify for priority review under the policies and procedures offered by the FDA, but the Fast Track designation does not assure any such qualification. Although we have obtained a Fast Track designation from the FDA for Prochymal for the treatment of GvHD and treatment refractory Crohn's disease, receipt of Fast Track designation may not result in a faster development process, review or approval compared to drugs considered for approval under conventional FDA procedures. In addition, the FDA may withdraw our Fast Track designation at any time. If we lose our Fast Track designation, the approval process may be delayed. In addition, our Fast Track designation does not guarantee that we will qualify for or be able to take advantage of the expedited review procedures and does not increase the likelihood that Prochymal will receive regulatory approval for the treatments of steroid refractory GvHD or Crohn's disease.

Should the FDA decide that Grafix or Ovation, or that any other Biosurgery product we may develop, does not meet the appropriate regulatory requirements, we may be required to stop production, which could have a material adverse effect on our business, financial condition and results of operations.

        The FDA has developed a tiered, risk-based regulatory framework, which includes criteria for facility management, quality assurance, donor selection, and processing of human cells, tissues, and cellular and tissue based products. We believe that commercial sale of Grafix and Ovation does not require pre-market approval by the FDA because we believe that these products meet the regulatory definition of human cells, tissue, and cellular and tissue-based products, or HCT/Ps. However, should the FDA decide that these products do not meet the regulatory definition of HCT/Ps, we will not be able to produce and redistribute these products until we obtain FDA approval, which could take years to obtain and which would have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Our Common Stock

The trading price of the shares of our common stock is highly volatile, and purchasers of our common stock could incur substantial losses.

        Our stock price is volatile. The stock market in general and the market for biotechnology companies in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. As a result of this volatility, investors may not be able to sell their common stock at or above the price they paid for it. The market price for our common stock may be influenced by many factors, including:

    results of clinical trials of our biologic drug candidates or those of our competitors;

    regulatory developments in the United States and foreign countries;

44


Table of Contents

    variations in our financial results or those of companies that are perceived to be similar to us;

    changes in the structure of healthcare payment systems;

    announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

    market conditions in the pharmaceutical and biotechnology sectors and issuance of securities analysts' reports or recommendations;

    sales of substantial amounts of our stock by existing stockholders;

    sales of our stock by insiders and 5% stockholders;

    general economic, industry and market conditions;

    additions or departures of key personnel;

    intellectual property, product liability or other litigation against us;

    expiration or termination of our relationships with our collaborators; and

    the other factors described in this "Risk Factors" section.

        In addition, in the past, stockholders have initiated class action lawsuits against biotechnology and pharmaceutical companies following periods of volatility in the market prices of these companies' stock. Such litigation, if instituted against us, could cause us to incur substantial costs and divert management's attention and resources, which could have a material adverse effect on our business, financial condition and results of operations.

Certain provisions of Maryland law and of our charter and bylaws contain provisions that could delay and discourage takeover attempts and any attempts to replace our current management by stockholders.

        Certain provisions of Maryland General Corporation Law (MGCL) and of our Maryland charter and Maryland bylaws contain provisions that may make it more difficult for or prevent a third party from acquiring control of us or changing our Board of Directors and management. These include, but are not limited to, the following:

    classification of the board of directors with staggered terms of three years, which prevents a majority of the incumbent directors from being replaced at a single annual stockholders' meeting;

    authorization of the board of directors to issue shares of preferred stock generally without stockholder approval;

    requirements that special meetings of stockholders may only be called by the chairman of the board of directors, upon request of stockholders holding at least 20% of the capital stock issued and outstanding, or upon a resolution adopted by, or an affirmative vote of, a majority of the board of directors; and

    requirements that our stockholders comply with advance notice procedures in order to nominate candidates for election to our Board of Directors or to place stockholders' proposals on the agenda for consideration at meetings of stockholders.

        Maryland law also prohibits "business combinations" between us and an interested stockholder or an affiliate of an interested stockholder for five years after the most recent date on which the interested stockholder becomes an interested stockholder. These business combinations include a merger, consolidation, share exchange or, in certain circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. Maryland law defines an interested

45


Table of Contents

stockholder as any person who beneficially owns 10% or more of the voting power of the corporation's stock, or an affiliate or associate of the corporation who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the corporation's then-outstanding voting stock. A person is not an interested stockholder if the board of directors of the corporation approved in advance the transaction by which the person otherwise would have become an interested stockholder. However, such approval may be conditional.

        After the five-year prohibition, any business combination between the corporation and an interested stockholder or an affiliate of an interested stockholder generally must be recommended by the board of directors and approved by the affirmative vote of at least 80% of the votes entitled to be cast by holders of the then-outstanding shares of voting stock, and two-thirds of the votes entitled to be cast by holders of the voting stock other than stock held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or stock held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if the holders of the common stock receive a minimum price, as defined under Maryland law, for their stock in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its stock.

        The statute permits various exemptions from its provisions, including business combinations that are approved or exempted by the board of directors before the time that the interested stockholder becomes an interested stockholder. Our Board of Directors has not exempted us from the business combination statute. Consequently, unless the Board of Directors adopts an exemption from this statute in the future, the statute will be applicable and may affect business combinations between us and other persons. The statute may discourage others from trying to acquire control of us or increase the difficulty of consummating any such acquisition.

        Our bylaws also contain a provision exempting us from the "control share acquisition" provisions of the MGCL (Sections 3-701 through 3-709). We can provide no assurance that such provision of our bylaws will not be amended or eliminated in the future. Should this happen, the control share acquisition provisions would become effective and may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.

        Subtitle 8 of Title 3 of the MGCL ("Subtitle 8") permits a Maryland corporation with a class of equity securities registered under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and with at least three independent directors to elect to be subject to any or all of five provisions:

    a classified board;

    a two-thirds vote requirement to remove a director;

    a requirement that the number of directors be fixed only by the vote of the directors;

    a requirement that a vacancy on the board be filled only by the remaining directors and for the remainder of the full term of the directorship in which the vacancy occurred rather than until the next annual meeting of stockholders as would otherwise be the case; and

    a majority requirement for the calling of a special meeting of stockholders.

        An eligible Maryland corporation like us can elect into this statute by provision in its charter or bylaws or by a resolution of its board of directors, without stockholder approval. Furthermore, we can elect to be subject to the above provisions regardless of any contrary provisions in the charter or bylaws. Pursuant to Subtitle 8, we have elected to provide that vacancies on our Board of Directors may be filled only by the remaining directors and for the remainder of the full term of the class of directors in which the vacancy occurred. Through provisions in our charter and bylaws unrelated to

46


Table of Contents

Subtitle 8, we have a classified board, and the number of our directors may be fixed only by the vote of the directors.

Concentration of ownership of our common stock among our existing executive officers, directors and principal stockholders may prevent others from influencing significant corporate decisions, and provisions in our charter allowing for a stockholder vote by consent in lieu of a meeting may make it easier for stockholders holding a majority of our common stock to take action.

        Our executive officers, directors and beneficial owners of 5% or more of our common stock and their affiliates, in aggregate, beneficially own approximately 53% of our outstanding common stock as of March 1, 2013. Included among this 53%, Peter Friedli, the Chairman of the Board of Directors, and certain entities with which he is affiliated, beneficially own approximately 43% of our outstanding common stock as of March 1, 2013. These persons, acting together, will be able to significantly influence all matters requiring stockholder approval, including the election and removal of directors and any merger or other significant corporate transactions. The interests of this group of stockholders may not coincide with our interests or the interests of other stockholders.

        Moreover, as permitted by the MGCL, our charter provides that the holders of common stock entitled to vote generally in the election of directors may take action or consent to any action by delivering a consent in writing or by electronic transmission of the stockholders entitled to cast not less than the minimum number of votes (which is generally either a majority of votes cast or a majority of votes entitled to be cast) that would be necessary to authorize or take the action at a stockholders meeting if the corporation gives notice of the action not later than ten (10) days after the effective date of the action to each holder of the class of common stock and to each stockholder who, if the action had been taken at a meeting, would have been entitled to notice of the meeting.

        Accordingly, these persons acting together, and Mr. Friedli specifically, currently has, and will continue to have, a significant influence over the outcome of all corporate actions requiring stockholder approval, including any actions that may be taken by stockholder consent in lieu of a meeting.

ITEM 1B.    Unresolved Staff Comments.

        Not Applicable.

ITEM 2.    Properties.

        Our corporate headquarters are located in Columbia, Maryland, where we lease approximately 61,000 square feet, currently at a rent of approximately $1.3 million per annum. This lease expires in July 2016, and includes options to extend the term of the lease for two additional five year periods.

ITEM 3.    Legal Proceedings.

        From time to time in the ordinary course of business, we are subject to claims, asserted or unasserted, or named as a party to lawsuits, arbitrations, or investigations. Litigation, in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings cannot be predicted with any certainty and in the case of more complex legal proceedings, such as intellectual property and securities litigation, the results are difficult to predict at all. We are not aware of any asserted or unasserted legal proceedings or claims that we believe would have a material adverse effect on our financial condition or results of our operations.

ITEM 4.    Mine Safety Disclosures.

        Not Applicable.

47


Table of Contents


PART II

ITEM 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

        Our common stock trades on the NASDAQ Global Market under the symbol "OSIR." The following table lists the high and low sale prices per share for our common stock based on the prices as reported on the NASDAQ Global Market for the periods indicated.

 
  2012   2011  
 
  High   Low   High   Low  

Quarter Ended

                         

March 31

  $ 6.09   $ 4.38   $ 8.10   $ 5.97  

June 30

    14.46     4.47     8.02     6.32  

September 30

    12.08     8.05     8.39     4.39  

December 31

    11.94     8.05     5.66     4.12  

Stockholders

        As of March 1, 2013, there were approximately 165 stockholders of record of our common stock and, according to our estimates, approximately 5,293 beneficial owners of our common stock.

Dividends

        We have not paid dividends to our stockholders since our inception and we do not plan to pay cash dividends in the foreseeable future. We currently intend to retain earnings, if any, to finance our growth.

Unregistered Sales of Securities

        There were no issuances of unregistered securities during fiscal 2012.

Issuer Purchase of Equity Securities and Use of Proceeds

        There were no repurchases by us of our securities during fiscal 2012 or 2011.

48


Table of Contents

Stock Performance Graph

        The following graph shows the cumulative total return, assuming the investment of $100 on August 4, 2006 (the date on which our initial public offering was declared effective and our common stock began trading on the NASDAQ Global Market), on an investment in each of our common stock, the NASDAQ Composite Index (U.S. and Foreign) and the NASDAQ Biotechnology Index. The comparisons in the table are required by the SEC and are not intended to forecast or be indicative of possible future performance of our common stock.

GRAPHIC

Securities Authorized for Issuance under Equity Compensation Plans

        The information required by Item 201(d) of Regulation S-K, pursuant to paragraph (a) of this Item 5, is incorporated herein by reference to the information contained in the Company's Proxy Statement for the 2013 Annual Meeting of Stockholders, which is anticipated to be filed pursuant to Regulation 14A no later than one hundred twenty (120) days following the end of the fiscal year reported on.

49


Table of Contents

ITEM 6.    Selected Financial Data.

        We derived the selected financial data presented below for the periods or dates indicated from our financial statements. Our financial statements for these periods were audited by an independent registered public accounting firm. You should read the data below in conjunction with our financial statements, related notes and other financial information appearing in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data." These historical results are not necessarily indicative of results that may be expected for future periods.

 
  Year Ended December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands, except per share data)
 

Statement of Operations Data:

                               

Revenue from collaborative research agreements, government contracts, and royalties

  $ 3,955   $ 41,140   $ 43,021   $ 44,533   $ 10,044  

Biosurgery product revenues

    7,849     1,263     183          

Gross profit on Biosurgery revenues

    5,298     732     121          

Operating expenses:

                               

Research and development

    14,108     19,156     23,501     63,266     69,897  

General and administrative and other expenses

    6,296     7,881     6,450     8,807     8,586  
                       

Total operating expenses

    20,404     27,037     29,951     72,073     78,483  
                       

(Loss) income from operations

    (11,151 )   14,835     13,191     (27,540 )   (68,439 )

Other income (expense), net

    49     100     175     1,277     (978 )
                       

(Loss) income from continuing operations, before income taxes

    (11,102 )   14,935     13,366     (26,263 )   (69,417 )

Income tax benefit (expense)

    37     (43 )   (241 )   2,699      
                       

(Loss) income from continuing operations

    (11,065 )   14,892     13,125     (23,564 )   (69,417 )

Income from discontinued operations, net of income taxes

                38,136     35,925  
                       

Net (loss) income

  $ (11,065 ) $ 14,892   $ 13,125   $ 14,572   $ (33,492 )
                       

Basic and diluted net (loss) income per share from continuing operations

  $ (0.34 ) $ 0.45   $ 0.40   $ (0.72 ) $ (2.18 )
                       

Basic and diluted net (loss) income per share

  $ (0.34 ) $ 0.45   $ 0.40   $ 0.45   $ (1.05 )
                       

Weighted average shares of common stock used in computing basic net (loss) income per share

    32,859     32,820     32,784     32,742     31,895  
                       

Weighted average shares of common stock used in computing diluted net (loss) income per share

    32,859     33,118     33,097     32,742     31,895  
                       

50


Table of Contents


 
  At December 31,  
 
  2012   2011   2010   2009   2008  
 
  (in thousands)
 

Balance Sheet Data:

                               

Cash and investments available for sale

  $ 34,092   $ 47,265   $ 67,608   $ 100,715   $ 62,238  

Working capital(1)

    33,993     43,393     27,423     52,362     70,599  

Total assets

    41,464     54,273     77,784     107,596     137,467  

Long-term liabilities

    531     430     3,798     44,597     84,278  

Accumulated deficit

    (243,392 )   (232,327 )   (247,219 )   (260,344 )   (274,916 )

Total stockholders' equity (deficit)

    35,890     45,818     27,457     12,560     (5,020 )

(1)
Working capital is computed as the excess of current assets over current liabilities.

ITEM 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

        When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risks and uncertainties described under "Risk Factors" included as Item 1A in this Annual Report on Form 10-K. These risks and uncertainties could cause actual results to differ materially from those forecasted in forward-looking statements or implied by past results and trends. Forward-looking statements are statements that attempt to project or anticipate future developments in our business; we encourage you to review the examples of forward-looking statements included in this Annual Report on Form 10-K under Item 1 at the beginning of this report. These statements, like all statements in this report, speak only as of the date of this report (unless another date is indicated), and we undertake no obligation to update or revise the statements in light of future developments.

        The following is a discussion and analysis of our financial condition, results of operations, liquidity and capital resources for each of the three years in the period ended December 31, 2012 and significant factors that could affect our prospective financial condition and results of operations. You should read this discussion together with our financial statements and notes included in "Item 8. Financial Statements and Supplementary Data."

Business Overview

        We are a leading stem cell company headquartered in Columbia, Maryland and focused on developing and marketing products to treat medical conditions in the inflammatory, cardiovascular, orthopedic and wound healing markets. We currently market and distribute Grafix and Ovation for tissue repair. Our pipeline of internally developed biologic drug candidates under evaluation includes Prochymal for inflammatory, autoimmune and cardiovascular indications, as well as Chondrogen for arthritis in the knee. We believe our stem cell products have significant therapeutic potential because of their ability to regulate inflammation, promote tissue regeneration and prevent pathological scar formation.

        We began operations on December 23, 1992 and were a Delaware corporation until, with approval of our stockholders, we reincorporated as a Maryland corporation on May 31, 2010.

        We have two business segments, Therapeutics and Biosurgery. Our Therapeutics business is focused on developing biologic stem cell drug candidates from a readily available and non-controversial source—adult bone marrow. Our Biosurgery business, created in 2009 and operating as a separate segment since 2010, works to harness the ability of cells and novel constructs to promote the body's natural healing with the goals of improving surgical outcomes and offering better treatment options for patients and physicians.

51


Table of Contents

        We believe cellular therapies have certain advantages over traditional medical approaches. For example, cell therapies can be targeted, avoiding many of the safety complications arising from systemic treatments. Cell therapies can also be responsive to their environment, turning on or off certain effects as conditions in the surrounding tissue change. Cell therapies can also be multifaceted. For example, the cells in Prochymal, our leading biologic drug candidate, have demonstrated the ability to not only downregulate inflammation, but also to promote repair of the damage caused by the inflammation.

        We believe the combination of these unique properties will allow us to solve many of the more challenging questions facing medicine today. We have established ourselves as an industry leader in the emerging field of cell therapy, having developed the first commercially available stem cell product.

        We are a fully integrated company, having developed capabilities in research, development, manufacturing, marketing and distribution of stem cell products. We have developed an extensive intellectual property portfolio to protect our technology in the United States and a number of foreign countries, including 50 U.S. and 156 foreign patents owned or licensed. We believe that our biologic drug candidates have advantages over other stem cell therapeutics in development for at least the following reasons:

    Stem Cell Source.  Our stem cells are obtained from adult bone marrow, a readily available source. The cells are drawn from the hips of volunteer donors between the ages of 18 and 30 years, using a simple needle and syringe aspiration. Because the cells are obtained from consenting adult donors, we are able to largely avoid the ethical controversy surrounding embryonic and fetal stem cell research.

    Ability to Mass Produce.  Through our proprietary manufacturing methods, we can grow mesenchymal stem cells ("MSC") in a controlled fashion to produce up to 10,000 treatments of our biologic drug candidates from a single bone marrow donation. Our ability to produce a large quantity of treatments from one donation provides us with manufacturing efficiencies and product consistency that are essential to commercialization.

    Universal Compatibility.  Many stem cell therapies under development can elicit a rejection response in the recipient and therefore require donor-to-recipient matching or potentially harmful immunosuppression. This greatly reduces manufacturing efficiencies and creates a risk of mismatch which can result in an acute inflammatory response and, potentially, in death. Based on our clinical experience, we believe that our biologic drug candidates are not rejected by the patient's immune system and so, like type O negative blood, do not require donor-to-recipient matching. This universal compatibility allows us to produce a standardized product available to all patients in almost any medical setting.

    Treatment on Demand.  Our biologic drug candidates can be stored frozen at end-user medical facilities until they are needed. We anticipate that medical facilities will be able to prescribe and dispense these products in much the same way as conventional drugs. In contrast, other stem cell technologies under development require weeks to prepare after a patient's need is identified. This is a key feature of our technology, as many patients in the critical care setting require prompt treatment.

        In the third fiscal quarter of 2009, we created our Biosurgery segment focused on developing, manufacturing and distributing high-end biologic products for use in surgical procedures. We launched our first biologic product during third quarter of fiscal 2010, and our Biosurgery business has continued to grow since that time. We anticipate continuing to increase our organizational focus on the development and commercialization of products in this segment as the revenues generated from Bisourgery products increase in the foreseeable future.

52


Table of Contents

Financial Operations Overview

Revenue

        Biosurgery Segment.    Beginning in fiscal 2010, we started to account for our Biosurgery business as a separate segment. We manufacture human tissue based products in our Columbia, Maryland facility and distribute these products through a network of independent distributors as well as employee sales personnel. We presently manufacture and distribute Grafix for the treatment of chronic wounds and burns and Ovation for orthopedic surgeries. Both of these products are cryo-preserved and stored in special freezers at -80 degrees Celsius. Customers have the product shipped to them in dry ice. Legal title passes to the customer when the product leaves our shipping dock. Due to the nature of the products and the manufacturing process, we do not allow sales returns.

        We launched our first Biosurgery product for limited commercial distribution during the third quarter of 2010. We began distribution of a second Biosurgery product in early fiscal 2011, and have continued to increase our distribution volume throughout fiscal 2011 and 2012, both through in-house personnel as well as through our expanding distributor network. The increase in revenue and gross profit since commercial launch is due to volume increases. We anticipate continuing to increase our organizational focus on the development and commercialization of products in this segment in the foreseeable future.

        Therapeutics Segment.    In the fourth quarter of 2008, we entered into a collaboration agreement with Genzyme Corporation, then an independent and now a Sanofi company, for the development and commercialization of Prochymal and Chondrogen. Under the terms of the agreement, we retained the rights to commercialize Prochymal and Chondrogen in the United States and Canada, and Genzyme was granted exclusive rights to commercialize Prochymal and Chondrogen in all other countries, except with respect to GvHD in Japan, where Prochymal has previously been licensed to JCR Pharmaceuticals Co., Ltd. Under the agreement, we were paid $130.0 million for these rights. During the fiscal quarter ended March 31, 2012 we recognized revenue of $3.3 million, which was the final deferred revenue associated with the $130.0 million upfront payment. We recognized $40.0 million of revenue from the amortization of the upfront payment during each of the fiscal year 2011 and 2010.

        The collaboration agreement provided that it would expire upon the completion of all development plans stipulated in the agreement and the expiration of all payment obligations; however, in addition to certain opt out rights, Genzyme could terminate the agreement early and without further obligation at any time, and either party could terminate the agreement due to non-performance, material breach or insolvency.

        In February 2012, Sanofi issued a press release which included an update on their R&D pipeline, stating that it had "discontinued" its project with Prochymal for GvHD, and in September 2012, we entered into a termination agreement with Sanofi that terminated the collaboration agreement and memorialized an amicable parting. Under the termination agreement, neither party has any continuing financial or other obligations to the other. We continue to proceed with our Prochymal regulatory and commercialization efforts.

        In 2007, we also partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In the first quarter of 2008, we were awarded a contract from the United States Department of Defense ("DoD") pursuant to which we, in partnership with Genzyme, sought to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from acute radiation exposure. Under the terms of this contract, we recognized $470,000 in revenue in fiscal 2010. No work is continuing under this contract and we are not presently pursuing other government contracts in partnership with Genzyme, or otherwise.

        In prior years, we entered into strategic agreements with other companies for the development and commercialization of Prochymal for specific indications and geographic markets. In 2007, we entered

53


Table of Contents

into a collaborative agreement with the Juvenile Diabetes Research Foundation (JDRF) to conduct a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes mellitus. This collaborative agreement provided for JDRF to provide $4.0 million of contingent milestone funding to support the development of Prochymal for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. The contingent milestone payments under the agreement have been amortized into revenue on a straight line basis over the duration of our obligations under the collaborative agreement as they were earned. As of December 31, 2011, we had achieved all $4.0 million of the milestones available under the contract and recognized the entire funding as revenue. In fiscal 2011, we recognized $960,000 in revenue and in fiscal 2010, we recognized $1.2 million in revenue. We recognized no revenue in connection with this project in 2012, and although we continue to follow patients who participated in the studies supported by this arrangement, our work is substantially complete.

        In 2003, we entered into an agreement with JCR Pharmaceuticals, granting it exclusive rights to Prochymal for the treatment of GvHD and other hematological malignancies in Japan. During the first quarter of 2010, we achieved a $1.0 million milestone from JCR for development progress in Japan. The collaboration with JCR also provides for additional milestone payments of up to $5.5 million for regulatory and sales milestones, as well as royalty payments on sales of the drug in Japan.

Research and Development Costs

        Our research and development costs consist of expenses incurred in identifying, developing and testing biologic drug candidates and biologic tissue based products. These expenses consist primarily of salaries and related expenses for personnel, fees paid to professional service providers for independent monitoring and analysis of our clinical trials, costs of contract research and manufacturing, costs of facilities, and the costs of manufacturing clinical batches of biologic drug candidates, quality control supplies and material to expand biologic drug candidates.

        Consistent with our focus on the development of biologic drug candidates with potential uses in multiple indications, many of our costs are not attributable to a specifically identified product. We use our employee and infrastructure resources across several projects. Accordingly, we do not account for internal research and development costs on a project-by-project basis. From inception in December 1992 through December 31, 2012, we incurred aggregate research and development costs of approximately $424 million.

        Beginning in 2010, with the creation of our Biosurgery segment, we began to separately track research and development costs by segment. Research and development expenses for our Therapeutics segment were $9.6 million, $15.8 million, and $19.1 million for fiscal years 2012, 2011, and 2010, respectively. Biosurgery research and development expenses for the comparable periods were $4.5 million, $3.3 million, and $4.4 million, respectively, which includes costs incurred for the study designed to allow for the collection of data necessary to obtain the permanent HCPCS Q-codes that began during the second fiscal quarter of 2012.

        As described above, we do not track internal development costs by project. We do, however, track external research and development costs on a project basis. During 2012, we incurred $2.0 million in external research and development costs on our acute myocardial infarction clinical trial, $1.2 million for the diabetic foot ulcer trial for our Biosurgery segment, $752,000 on our Refractory Crohn's disease clinical trial, $681,000 on Treatment-resistant GvHD and $638,000 on smaller projects. During fiscal 2011, we incurred $6.3 million in external research and development costs on our acute myocardial infarction clinical trial, $1.4 million on our Refractory Crohn's disease clinical trial, $830,000 on Treatment-resistant GvHD and $400,000 on smaller projects. For 2010, our external research and development costs were approximately $2.8 million for Prochymal to treat first line and steroid refractory acute GvHD, $905,000 for Prochymal to treat Crohn's disease, $4.1 million for Prochymal to

54


Table of Contents

repair heart tissue following a heart attack, $1.7 million for Prochymal for the protection of pancreatic islet cells in patients with type 1 diabetes, $700,000 for Prochymal to treat COPD, and approximately $225,000 for smaller projects.

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

    the number of patients who participate in the trials;

    the number of sites included in the trials;

    the length of time required to enroll trial participants;

    the duration of patient treatment and follow-up;

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

    the efficacy and safety profile of the biologic drug candidate; and

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

        As a result of these uncertainties, we are unable to determine with any significant degree of certainty the duration and completion costs of our research and development projects or when and to what extent we will generate revenues from the commercialization and sale of any of our biologic drug candidates.

General and Administrative Expenses

        General and administrative expenses consist primarily of the costs associated with our general management, including salaries, allocations of facilities and related costs, and professional fees such as legal and accounting expenses. Generally, we have experienced a decrease in general and administrative costs as the result of our continued cost cutting efforts and the refinement of many of our general business processes, as well as a reduction in share-based compensation expense. Beginning in fiscal 2012, we incurred additional general and administrative expenses related to increased distribution efforts for our Biosurgery products. We expect future expense increases to continue as a result of hiring additional operational, financial, accounting, facilities engineering and information systems personnel as we continue to increase distribution of our Biosurgery products and approach the commercial launch of Prochymal for an initial indication.

Other Income, Net

        Other income consists of interest earned on our cash and investments available for sale and realized gains and losses incurred on the sale of these investments. Interest expense consists of interest incurred on capital leases. We do not expect to incur material interest expense in the future as we do not have a material amount of equipment under capital lease or any outstanding debt.

55


Table of Contents

Income Taxes

        Until fiscal 2010, we have not recognized any net deferred tax assets or liabilities in our financial statements since we cannot assure their future realization. Because realization of deferred tax assets is dependent upon future earnings, a full valuation allowance has been recorded on the net deferred tax assets, which relate primarily to net operating loss and research and development carry-forwards. In the event that we become profitable within the next several years, we have net deferred tax assets (before a 100% valuation allowance) of approximately $93.6 million that may be utilized prior to us having to recognize any income tax expense or make payments to the taxing authorities other than the alternative minimum tax. The income from the upfront fees we received from Genzyme Corporation was required to be recognized over several years from 2008 through 2012 for financial statement reporting purposes. For income tax purposes, the income was required to be fully recognized in 2009 and 2010. This resulted in our releasing $3.2 million of the valuation allowance on our net deferred tax assets in fiscal 2010. We recognized $1.0 million of the resulting deferred tax asset in 2011, and recognized the remaining $2.2 million deferred tax asset in 2012.

        In fiscal 2010, we recorded a provision for income taxes to recognize the U.S. Federal alternative minimum tax on our taxable income. In fiscal 2011, we recorded a provision for income taxes of $43,000 to recognize a true-up of the 2010 payables account that was identified when we filed our 2010 Federal income tax return. The effective tax rate of .3%, as compared to a U.S. statutory rate of 35%, reflects this adjustment. We do not expect to be subject to the U.S. Federal alternative minimum tax in fiscal 2011. The tax provision for 2010 reflects an effective tax rate for continuing operations of 1.8% compared to a U.S. statutory tax rate of 35%. The effective tax rate reflects our estimated annual effective tax rate, which reflects our expectation that a portion of our income will be subject to the Federal alternative minimum tax in 2010, which is almost entirely offset by a release of valuation allowance discussed above. In fiscal 2012 we recognized an income tax benefit of $37,000, in connection with truing up our tax asset accounts in connection with the filing of our 2011 income tax returns.

Critical Accounting Policies

General

        Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, inventory valuation, deferred tax assets, share-based compensation, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable. These results form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        We believe that the following critical accounting policies reflect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

        As discussed in Note 3—Segment Reporting below, in 2010 we began operations of our Biosurgery segment, focused on developing high-end biologic products for use in wound healing and surgical procedures. We commenced the manufacturing of our first Biosurgery product, Grafix, a regenerative wound care product, during the first quarter of 2010. During the first and second quarters of 2010, we distributed the product only for initial clinical evaluation. We launched the product for limited commercial distribution during the third quarter of 2010. We began distribution of a second Biosurgery

56


Table of Contents

product, Ovation in early fiscal 2011, and continued to increase our distribution volume throughout fiscal 2011 and 2012. We recognized revenues of $7.8 million and $1.3 million on distribution of our Biosurgery products in 2012 and 2011, respectively, compared to $183,000 subsequent to commercial launch in fiscal 2010.

        We recognize revenue on the distribution of our Biosurgery products when we ship the frozen product to our customers. Legal title passes to the customers when the product leaves our shipping dock. Due to the nature of the products and the manufacturing process, we do not allow sales returns or refunds.

        To date, our Therapeutics segment has generated revenues primarily from collaborative agreements and research licenses. We evaluate revenues from agreements that have multiple elements to determine whether the components of the arrangement represent separate units of accounting. To recognize a delivered item in a multiple element arrangement, the delivered items must have value on a standalone basis and the delivery or performance must be probable and within our control for any delivered items that have a right of return. The determination of whether multiple elements of a collaboration agreement meet the criteria for separate units of accounting requires us to exercise judgment.

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

        In October 2008, we entered into a Collaboration Agreement with Genzyme Corporation, then an independent and now a Sanofi company ("Genzyme"), for the development and commercialization of our biologic drug candidates, Prochymal and Chondrogen®. Under this agreement, Genzyme made non-contingent, non-refundable cash payments to us, totaling $130.0 million. The agreement provided Genzyme with certain rights to intellectual property developed by us, and required that we continue to perform certain development work related to the subject biologic drug candidates. In February 2012, Sanofi issued a press release which included an update on their R&D pipeline, stating that it had discontinued its project with Prochymal for GvHD. In September 2012, we reached agreement with Sanofi to conclude the Collaboration Agreement without either party having any continuing obligation to the other. We are continuing to proceed with our Prochymal regulatory approval and commercialization efforts.

        We evaluated the deliverables related to the upfront payments made to us under the Genzyme collaboration agreement, and concluded that the various deliverables represent a single unit of accounting. For this reason, we deferred the recognition of revenue related to the upfront payments, and amortized these amounts to revenue on a straight-line basis over the estimated delivery period of the required development services, which extended through January 2012.

        Accordingly, we recognized $3.3 million of revenue from this agreement during 2012, all of which came during the first fiscal quarter corresponding with the estimated end point date in January of 2012, compared to $40.0 million of revenue in each of the years ended December 31, 2011 and 2010 related to the amortization of the upfront payments.

        In 2007, we also partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the United States Department of Defense ("DoD") pursuant to which we sought, in partnership with Genzyme, to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting

57


Table of Contents

from acute radiation exposure. We began recognizing revenue under this contract in 2008, and completed our work under the contract during 2010. Contract revenue was recognized as the related costs were incurred, in accordance with the terms of the contract. We recognized approximately $471,000, in revenue from the DoD contract during 2010. We have not recognized any revenue associated with this contract during fiscal 2012 or 2011, and the agreement with Genzyme expired in July 2010.

        In October 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation ("JDRF") to conduct a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes mellitus. This collaborative agreement provides for JDRF to provide up to $4.0 million of contingent milestone funding to support the development of Prochymal for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. The contingent milestone payments under the agreement are amortized to revenue on a straight line basis over the duration of our obligations under the collaborative agreement as they are received and earned. We have received all $4.0 million of the contingent milestones, and amortized the funding received over the duration of our obligations. We completed the majority of our work under this contract in fiscal 2011, resulting in $1.0 million in revenue during 2011 compared to $1.2 million of revenue during 2010. We have not recognized any revenue associated with this contract during fiscal 2012, but are continuing to monitor the trial participants through early fiscal 2013.

        We have also entered into strategic agreements with other pharmaceutical companies focusing on the development and commercialization of our stem cell drug candidates. For example, in 2003, we entered into an agreement with JCR Pharmaceuticals Co., Ltd. ("JCR") pertaining to hematologic malignancies (GvHD) drugs for distribution in Japan. Under such agreements, we receive fees for licensing the use of our technology. We recognized $1.0 million of revenue during the first fiscal quarter of 2010 from JCR upon the achievement of a milestone event specified in the agreement.

        Our Therapeutics segment also earns royalty revenues and cost reimbursement under our adult expanded access program. Royalties are earned on the sale of human mesenchymal stem cells sold for research purposes. We recognize this revenue as sales are made. Revenues include approximately $305,000 of royalty revenue in 2012, $65,000 of royalty revenue in 2011 and $300,000 of royalty revenue in 2010. Revenues also include approximately $296,000, $115,000, and $41,000 in cost reimbursement for Prochymal used in our adult expanded access program during 2012, 2011, and 2010, respectively.

Investments Available for Sale and Other Comprehensive Income

        Investments available for sale consist primarily of marketable securities with maturities less than one year. Investments available for sale are valued at their fair value, with unrealized gains and losses reported as a separate component of stockholders' equity in accumulated other comprehensive income. All realized gains and losses on our investments available for sale are recognized in results of operations as investment income, a component of "Other income (expense), net".

        Investments available for sale are evaluated periodically to determine whether a decline in their value is "other than temporary." Management reviews criteria such as the magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. If a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Accounts Receivable

        Accounts receivable are reported at their net realizable value. We charge off uncollectible receivables when the likelihood of collection is remote. We set credit terms with individual customers, and consider receivables outstanding longer than the time specified in the respective customer's contract, typically 45-days, to be past due. As of December 31, 2012 and 2011, accounts receivable in

58


Table of Contents

the accompanying balance sheet are reported net of a $25,000 and a $3,000 allowance for doubtful accounts, respectively. We believe the reported amounts are fully collectible. Accounts receivable balances are not collateralized. We have incurred bad debt expense of $22,000 and 3,000 related to our biosurgery operations during fiscal 2012 and 2011, respectively, and no bad debts expense during the year ended December 31, 2010.

Inventory

        We commenced limited distribution of our Biosurgery products during the third quarter of 2010, and began carrying inventory on our balance sheet thereafter. Inventory consists of raw materials, biologic products in process, and products available for distribution. We determine our inventory values using the first-in, first-out method. Inventory is valued at the lower of cost or market, and excludes units that we anticipate distributing for clinical evaluation.

        We do not currently carry any inventory for our Therapeutics products, as we have yet to launch Prochymal for commercial distribution following its approval in Canada during the second quarter of 2012, and subsequent approval in New Zealand. Historically, our Therapeutics segment operations have focused on clinical trials and discovery efforts, and accordingly, manufactured clinical doses of our drug candidates were expensed as incurred, consistent with our accounting for all other research and development costs. Once we begin commercial distribution, all newly manufactured Prochymal doses will be allocated either for use in commercial distribution, which will be carried as inventory and not expensed, or for research and development efforts, which will continue to be expensed as incurred.

Valuation of Long-lived Assets

        We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. Assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized for the difference between the fair value and carrying value of assets. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. There were no impairment losses recognized during the fiscal years 2012, 2011 or 2010.

Research and Development Costs

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

        Beginning in 2010, with the creation of our Biosurgery segment, we began to separately track research and development costs by segment. Research and development expenses for our Therapeutics segment were $9.6 million, $15.8 million, and $19.1 million for fiscal years 2012, 2011, and 2010, respectively. Biosurgery research and development expenses for the comparable periods were $4.4 million, $3.3 million, and $4.4 million, respectively, which includes costs incurred for the study designed to allow for the collection of data necessary to obtain the permanent HCPCS Q-codes that began during the second fiscal quarter of 2012.

        As described above, we do not track internal development costs by project. We do, however, track external research and development costs on a project basis. During 2012, we incurred $2.0 million in

59


Table of Contents

external research and development costs on our acute myocardial infarction clinical trial, $1.2 million for the diabetic foot ulcer trial for our Biosurgery segment, $752,000 on our Refractory Crohn's disease clinical trial, $681,000 on Treatment-resistant GvHD and $638,000 on smaller projects. During fiscal 2011, we incurred $6.3 million in external research and development costs on our acute myocardial infarction clinical trial, $1.4 million on our Refractory Crohn's disease clinical trial, $830,000 on Treatment-resistant GvHD and $400,000 on smaller projects. For 2010, our external research and development costs were approximately $2.8 million for Prochymal to treat first line and steroid refractory acute GvHD, $905,000 for Prochymal to treat Crohn's disease, $4.1 million for Prochymal to repair heart tissue following a heart attack, $1.7 million for Prochymal for the protection of pancreatic islet cells in patients with type 1 diabetes, $700,000 for Prochymal to treat COPD, and approximately $225,000 for smaller projects.

Income Taxes

        Deferred tax liabilities and assets are recognized for the estimated future tax consequences of temporary differences, income tax credits and net operating loss carry-forwards. Temporary differences are primarily the result of the differences between the tax bases of assets and liabilities and their financial reporting values. Deferred tax liabilities and assets are measured by applying the enacted statutory tax rates applicable to the future years in which deferred tax liabilities or assets are expected to be settled or realized. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense, if any, consists of the taxes payable for the current period and the change during the period in deferred tax assets and liabilities.

        We recognize in our financial statements the impact of a tax position, if that position is more likely than not to be sustained upon an examination, based on the technical merits of the position. Interest and penalties related to income tax matters are recorded as income tax expense. At December 31, 2012 and 2011, we had no accruals for interest or penalties related to income tax matters.

Share-Based Compensation

        We account for share-based payments using the fair value method.

        We recognize all share-based payments to employees and non-employee directors in our financial statements based on their grant date fair values, calculated using the Black-Scholes option pricing model. Compensation expense related to share-based awards is recognized on a straight-line basis based on the value of share awards that are expected to vest during the requisite service period on the grant date, which is revised for forfeitures.

Results of Operations

Year ended December 31, 2012 compared to December 31, 2011

Biosurgery Product Revenues & Gross Profit

        During fiscal 2012, we continued to expand our distribution efforts in our Biosurgery segment, both through in-house personnel as well as through our expanding distributor network. During fiscal 2012, we recognized $7.8 million of product revenues from the distribution of Grafix and Ovation and realized gross profit of $5.3 million, compared to $1.3 million of product revenues and $732,000 of gross profit during 2011. The increase in revenue and gross profit in 2012 is due to volume increases, as we have continued to expand our distribution network. We are continuing to distribute a substantial amount of these products for clinical evaluation and expect commercial distribution to ramp up slowly until such time as we are able to build the commercial capabilities necessary to drive more widespread adoption. Until such time as we ramp up our Biosurgery manufacturing activities to fully utilize our manufacturing facilities, our costs to manufacture these products are likely to vary significantly.

60


Table of Contents

Realized gross profits represent 66% of revenues during fiscal 2012 compared to 58% of revenues during fiscal 2011. We anticipate continuing to increase our organizational focus on the development and commercialization of products in this segment in the foreseeable future.

Revenues from Collaborative Research Agreements, Government Contract and Royalties

        Revenues from collaborative research agreements and royalties were $4.0 million for fiscal 2012, compared to $41.1 million for the fiscal 2011. We recognized the final $3.3 million in revenue from our collaborative agreement with Genzyme during January 2012, and over the course of the year recognized approximately $305,000 of royalty revenues and approximately $300,000 in cost reimbursement under our adult expanded access program. All of the revenue from the JDRF collaboration had been recognized prior to 2012. Revenues for fiscal 2011 included $40.0 million in revenue from the collaborative agreement with Genzyme, $960,000 from our collaboration with JDRF, $115,000 from our compassionate use protocol for treatment resistant GvHD in adults and $65,000 in royalties.

Research and Development Expenses

        Research and development expenses for 2012 were $14.1 million as compared to research and development expenses of $19.2 million for 2011, as follows:

 
  Year Ended
December 31,
 
 
  2012   2011  
 
  ($000)
  ($000)
 

Therapeutics

  $ 9,573   $ 15,829  

Biosurgery

    4,535     3,327  
           

  $ 14,108   $ 19,156  
           

        The decrease in research and development expenses in our Therapeutics segment reflects lower expenses in our acute myocardial infarction clinical trial, which was fully enrolled in the third quarter of 2011, resulting in lower patient and site costs since then and reduced activity in our Crohn's disease clinical trial. The increase in research and development expenses in our Biosurgery segment in fiscal 2012 reflects our increased process improvement efforts and development expenses incurred in exploring additional products to bring to market and the enrollment of the clinical trial required to obtain cost reimbursement for Grafix.

General and Administrative Expenses

        General and administrative expenses during fiscal 2012 were $6.1 million compared to $5.9 million during fiscal 2011. We incurred $2.4 million of sales, general and administrative expenses related to our Biosurgery segment during 2012, compared to $801,000 in 2011. The increase in our Biosurgery related general and administrative expenses reflects the additional sales, marketing and commission expenses incurred as we increase our distribution efforts. General and administrative expenses incurred in our Therapeutics segment during fiscal 2012 were $3.7 million compared to $5.1 million in fiscal 2011. The decrease is the result of our continued cost cutting efforts and the refinement of many of our general business processes, as well as our increased focus of internal resources on our Biosurgery operations.

Other Income, net

        Other income, net consists of our net realized investment income earned on our investments available for sale. Other income, net was $49,000 during fiscal 2012 and $100,000 during fiscal 2011. The decrease between years reflects the reductions in our investments available for sale to fund our operations combined with the very low yields offered on investment grade securities during fiscal 2012.

61


Table of Contents

Income taxes

        An income tax benefit of $37,000 was recognized during fiscal 2012 as a result of the true-up of our tax asset accounts in connection with the filing of our 2011 tax returns, compared to an income tax expense of $43,000 recognized in fiscal 2011.

Fees Paid to Related Parties, Including Share-Based Payments

        Share-based payments to members of our Board of Directors were $127,000 during fiscal 2012, compared to $1.9 million during fiscal 2011. The fiscal 2011 charge includes a one-time non cash charge of approximately $1.7 million related to the extension of the expiration date of a warrant held by the chairman of our board of directors. This transaction was approved by our stockholders at our 2011 annual meeting. Non-employee members of our board of directors are compensated by an annual award of stock that is paid in either unrestricted shares of our common stock or cash, or a combination of stock and cash. During fiscal 2012, we issued 25,000 shares of common stock and paid $25,000 cash to our non-employee directors. During fiscal 2011, we issued 25,000 shares of common stock and paid $36,000 cash to these individuals.

Year ended December 31, 2011 compared to December 31, 2010

Biosurgery Product Revenues & Gross Profit

        We began developing an internal distribution network as well as increasing our external network of distributors for our Biosurgery products during fiscal 2011. During fiscal 2011, we recognized revenues of $1.3 million and gross profit of $732,000 on Biosurgery products, compared to $183,000 of revenues and $121,000 of gross profit during fiscal 2010. Our gross profit in 2011 was approximately 58% of revenues compared to approximately 66% of revenues during 2010. We expect our gross profit to vary while we continue to increase distribution and more fully utilize our production facilities in a consistently efficient manner.

Revenues from Collaborative Research Agreements, Government Contract and Royalties

        Revenues from collaborative research agreements and royalties were $41.1 million during fiscal 2011 compared to $43.0 million during fiscal 2010. During fiscal 2011, we recognized $40.0 million in revenue from the collaborative agreement with Genzyme, $960,000 from our collaboration with JDRF, $115,000 from our compassionate use protocol for treatment resistant GvHD in adults and $65,000 in royalties. Our revenues for fiscal 2010 also included $40.0 million from the Genzyme agreements, $1.2 million from the JDRF collaboration, $1.0 million milestone payment from the license agreement with JCR Pharmaceuticals and $470,000 for the contract with the United States Department of Defense.

Research and Development Expenses

        Research and development expenses during fiscal 2011 were $19.2 million compared to $23.5 million during fiscal 2010, as follows:

 
  Year Ended December 31,  
 
  2011   2010  
 
  ($000)
  ($000)
 

Therapeutics

  $ 15,829   $ 19,102  

Biosurgery

    3,327     4,399  
           

  $ 19,156   $ 23,501  
           

62


Table of Contents

        The decline in Therapeutics R&D expenses during fiscal 2011 of approximately $3.3 million is principally related to the completion of the majority of patient treatment costs in our Phase 2 cardiac trial, while the decline in Biosurgery R&D is primarily attributable to the high volume of product development costs incurred for that segment in fiscal 2010 as we prepared for commercial launch..

General and Administrative Expenses

        General and administrative expenses during fiscal 2011 were $5.9 million compared to $6.3 million during fiscal 2010. The change between fiscal years is not material.

Other Income, net

        Other income, net consists of our net realized investment income earned on our investments available for sale. Other income, net was $100,000 during fiscal 2011 and $175,000 during fiscal 2010. The decrease between years reflects the reductions in our investments available for sale to fund our operations combined with the very low yields offered on investment grade securities.

Income taxes

        Income taxes of $43,000 was recognized in fiscal 2011 and resulted from the true-up of our tax asset accounts in connection with the filing of our 2010 income tax returns. Income taxes of $241,000 was recognized during fiscal 2010 and consists of Federal income tax of $2.7 million, state income tax of $1.2 million, net of the release of valuation allowance release of $3.2 million and the true of our income tax payable account to the 2009 income tax returns.

Fees Paid to Related Parties, Including Share-Based Payments

        Share-based payments to members of our Board of Directors were $1.9 million during fiscal 2011 compared to $74,000 during fiscal 2010. The fiscal 2011 charge includes the one-time non cash charge of approximately $1.7 million related to the extension of the expiration date of a warrant held by the chairman of our board of directors. During fiscal 2011, we issued 25,000 shares of common stock and paid $36,000 cash to our non-employee directors. During fiscal 2010, we issued 11,500 shares of common stock and paid $74,000 cash to our non-employee directors.

Liquidity and Capital Resources

Liquidity

        At December 31, 2012, we had $1.9 million in cash and $32.2 million in investments available for sale. In addition, we have not had any outstanding debt at any time since fiscal 2008.

        During the fiscal year ended December 31, 2008, we generated cash from operating activities for the first time since our inception, as a result of the $75.0 million portion of the up front fees received under the Collaboration Agreement with Genzyme. We generated a further $55.0 million of cash in up front fees during fiscal 2009. We used a portion of these proceeds to completely extinguish our debt during 2008, and have since consistently made purchases of investments available for sale with our excess cash. We have used these receipts to fund our operations since fiscal 2008. With the commercial launch of our Biosurgery products, we have begun to generate cash from product revenues. Although there can be no assurances, we believe that we have sufficient liquidity on hand as of December 31, 2012 to fund our operations through such time as our Biosurgery operations become cash flow positive and/or we begin to generate cash from our first biological drug candidate.

63


Table of Contents

Cash Flow

        The following table sets forth a summary of our cash flows for each of our three most recently completed fiscal years:

 
  Years Ended December 31,  
 
  2012   2011   2010  
 
  (amounts in thousands)
 

Net cash used in operating activities

  $ (13,271 ) $ (20,436 ) $ (33,189 )

Net cash provided by investing activities

    13,324     20,504     33,180  

Net cash provided by financing activities

    141     151     145  

        Net cash used in operating activities during fiscal 2012 was $13.3 million, and primarily reflects our net loss of $11.1 million and $3.3 million of the amortization of deferred revenue related to the Genzyme collaboration agreement, partially offset by $1.8 million of non cash charges included in the net loss.

        Net cash used in operating activities during fiscal 2011 was $20.4 million, and primarily reflects the amortization of deferred revenue related to the Genzyme collaboration agreement, partially offset by our net income of $14.9 million and non cash expenses of $4.2 million.

        Net cash used in operating activities was $33.2 million for the twelve months ended December 31, 2010, primarily reflecting the amortization of the deferred revenue received from Genzyme, partially offset by our net income.

        Net cash provided by investing activities was $13.3 million, $20.5 million, and $33.2 million, respectively, during fiscal years 2012, 2011, and 2010, and in each year primarily reflects proceeds from the sales of our investments to fund our operations.

        Net cash provided by financing activities was insignificant in each of the three years ended December 31, 2012.

Capital Resources.

        Our future capital requirements will depend on many factors, including:

    the scope and results of our research and preclinical development programs;

    the scope and results of our clinical trials, particularly regarding the number of patients required for our Phase 3 trials;

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

    the costs of maintaining, expanding and protecting our intellectual property portfolio, including possible litigation costs and liabilities; and

    the costs of enlarging our work force consistent with expanding our business and operations and distribution of our Biosurgery products and if approved for sale, our biological drug product.

        We did not have any outstanding debt at any time during 2012. As a result of our financial position and forecasts as of December 31, 2012, we believe that we have sufficient liquidity on hand as of that date to fund our operations through such time as our Biosurgery operations become cash flow positive and/or we begin to generate cash from our first biological drug candidate.

64


Table of Contents

Off-Balance Sheet Arrangements.

        We have no off-balance sheet financing arrangements and we have not entered into any transactions involving unconsolidated subsidiaries or special purpose entities.

Future Contractual Obligations

        The following table sets forth our estimates as to the amounts and timing of contractual payments for our most significant contractual obligations at December 31, 2012. The information in the table reflects future unconditional payments and is based on the terms of the relevant agreements, appropriate classification of item under accounting principles generally accepted in the United States and certain assumptions. Future events could cause actual payments to differ from these amounts.

 
  Payment Due by Fiscal Year  
Contractual Obligations
  Total   Less Than
1-Year
  Years 1-3   Years 4-5   More Than
5-Years
 
 
  (amounts in thousands)
 

Operating lease—facilities

  $ 4,102   $ 1,137   $ 2,359   $ 606   $  

Capital lease obligations

    216     48     96     72      

Contract Research Organizations

    5,962     4,418     1,544          
                       

Total contractual cash obligations

  $ 10,280   $ 5,603   $ 3,999   $ 678   $  
                       

        Contract Research Organizations.    We contract with independent contract research organizations, or CROs, to perform many of the tasks required under our clinical trials of our biological drug candidates, and we utilize their testing expertise to ensure the objectivity of the clinical results. Under the terms of these agreements, we design the protocol regarding the testing to be performed, and the CRO assists in the enrollment of the patients and testing sites, administers the trial, performs statistical analysis of the results, and compiles the final report.

        We pay fees directly to the CROs for their professional services, which may be payable upon specified trial milestones or as they provide services, depending on the structure of the contract. We are also responsible for reimbursing the CROs for certain pass thru expenses they incur in administering the trial. The timing of our payments to the CROs is dependent upon the progress of the various trials, which is highly variable dependent upon the speed with which the CROs are able to enroll patients and testing sites. As such, we are unable to specifically predict the timing of future payments to CROs.

        As of December 31, 2012, we had active contracts with CROs related to three on-going clinical trials which were in varying stages of completion. The total contracted payments to CROs under these agreements were $23.9 million, of which we had incurred approximately $17.9 million as of that date. Although we cannot directly control the timing of the remaining payments, based on our estimates and assumptions as of December 31, 2012, we expect to pay $4.4 million of our remaining obligations to these CROs during 2013 and the remainder in 2014.

        Leases.    During 2006, we entered into a sublease agreement for approximately 61,000 square feet of laboratory, production, warehouse and office space in Columbia, Maryland. We have also entered into a direct lease with the owner of this facility that was effective as of June 1, 2009 upon the expiration of the sublease and expires in July 2016. During 2009, following the expiration of the sublease agreement, we increased an outstanding letter of credit, which was used in lieu of a security deposit for this lease, to $591,000 according to the terms of the direct lease with the owner of the facility. At each of July 1, 2012, 2011, and 2010, the security deposit required under this lease decreased to $298,000, $372,000 and $446,000, respectively. We reduced our outstanding letter of credit

65


Table of Contents

accordingly, and the reduced letter of credit of $298,000 remained outstanding as of December 31, 2012, and has been fully collateralized by restricted cash.

Effect of Inflation.

        Inflation and changing prices are not generally a material factor affecting our business. General operating expenses such as salaries, employee benefits and lease costs are, however, subject to normal inflationary pressures.

ITEM 7A.    Quantitative and Qualitative Disclosures about Market Risk.

    Interest Rate Risk

        Due to the short duration of our investment portfolio and the high quality of our investments, an immediate 10% change in interest rates would not have a material effect on the value of our portfolio. Therefore, we would not expect our operating results or cash flows to be affected to any material degree by the effect of a sudden change in market interest rates on our securities portfolio.

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

    Foreign Current Exchange Rate Risk

        We conduct clinical trial activities in areas that operate in a functional currency other than the United States dollar (USD). As a result, when the USD rises and falls against the functional currencies of these other nations, our costs will either increase or decrease by the relative change in the exchange rate. Foreign currency gains and losses were not material during the three years ended December 31, 2012, and at the present time, we have elected not to hedge our exposure to foreign currency fluctuations.

    Derivative Instruments

        We do not enter into hedging or derivative instrument arrangements.

66


Table of Contents

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        OSIRIS THERAPEUTICS, INC.

FINANCIAL STATEMENTS

INDEX

*
All other information and financial statement schedules are omitted because they are not applicable, or required, or because the required information is included in the consolidated financial statements or notes thereto.

67


Table of Contents


REPORT OF MANAGEMENT

Management's Report on Financial Statements

        Our management is responsible for the preparation, integrity and fair presentation of information in our financial statements, including estimates and judgments. The financial statements presented in this Annual Report on Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America. Our management believes the financial statements and other financial information included in this Annual Report on Form 10-K fairly present, in all material respects, our financial condition, results of operations and cash flows as of and for the periods presented in this Annual Report on Form 10-K. The financial statements included herein have been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report.

Management's Report on Internal Control over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

        Our internal control over financial reporting includes those policies and procedures that:

    pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;

    provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorization of our management and our directors; and

    provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of such controls in future periods are subject to the risk that the controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.

        Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2012. In making this assessment, our management used the criteria set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on its assessment, our management concluded that, as of December 31, 2012, our internal control over financial reporting was effective based on those criteria.

        Grant Thornton LLP has issued an attestation report on our internal control over financial reporting. This report is included in the Report of Independent Registered Public Accounting Firm on the following page.

68


Table of Contents


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders of
Osiris Therapeutics, Inc.

        We have audited the internal control over financial reporting of Osiris Therapeutics, Inc. (a Maryland Corporation) (the "Company") as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by COSO.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements of the Company as of and for the year ended December 31, 2012, and our report dated March 15, 2013 expressed an unqualified opinion on those financial statements.

/s/ Grant Thornton LLP

Baltimore, Maryland
March 15, 2013

69


Table of Contents


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders of
Osiris Therapeutics, Inc.

        We have audited the accompanying balance sheets of Osiris Therapeutics, Inc. (a Maryland corporation) (the "Company") as of December 31, 2012 and 2011, and the related statements of comprehensive (loss) income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Osiris Therapeutics, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 15, 2013 expressed an unqualified opinion.

/s/ Grant Thornton LLP

Baltimore, Maryland
March 15, 2013

70


Table of Contents


OSIRIS THERAPEUTICS, INC.

BALANCE SHEETS

(amounts in thousands, except per share amounts)

 
  December 31,  
 
  2012   2011  

Assets

             

Current assets:

             

Cash

  $ 1,854   $ 1,661  

Investments available for sale

    32,238     45,730  

Accounts receivable, net

    3,063     728  

Inventory

    1,278     767  

Deferred tax asset

        2,188  

Prepaid expenses and other current assets

    603     344  
           

Total current assets

    39,036     51,418  

Property and equipment, net

    2,111     2,463  

Restricted cash

    317     392  
           

Total assets

  $ 41,464   $ 54,273  
           

Liabilities and Stockholders' Equity

             

Current liabilities:

             

Accounts payable and accrued expenses

  $ 4,999   $ 4,692  

Capital lease obligations, current portion

    44      

Deferred revenue, current portion

        3,333  
           

Total current liabilities

    5,043     8,025  

Long-term portion of capital lease obligations

    162      

Other long-term liabilities

    369     430  
           

Total liabilities

    5,574     8,455  
           

Commitments and contingencies

             

Stockholders' equity

             

Common stock, $.001 par value, 90,000 shares authorized, 32,881 shares outstanding—2012, 32,828 shares outstanding—2011

    33     33  

Additional paid-in-capital

    279,269     278,092  

Accumulated other comprehensive (loss) income

    (20 )   20  

Accumulated deficit

    (243,392 )   (232,327 )
           

Total stockholders' equity

    35,890     45,818  
           

Total liabilities and stockholders' equity

  $ 41,464   $ 54,273  
           

   

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

71


Table of Contents


OSIRIS THERAPEUTICS, INC.

STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(amounts in thousands, except per share data)

 
  Year ended December 31,  
 
  2012   2011   2010  

Product revenues

  $ 7,849   $ 1,263   $ 183  

Cost of product revenues

    2,551     531     62  
               

Gross profit

    5,298     732     121  
               

Revenue from collaborative research agreements and royalties

    3,955     41,140     43,021  

Operating expenses:

                   

Research and development

    14,108     19,156     23,501  

General and administrative

    6,144     5,927     6,289  

Fees paid to related parties

    25     36     87  

Share-based payments to related parties

    127     1,918     74  
               

    20,404     27,037     29,951  
               

(Loss) income from operations

    (11,151 )   14,835     13,191  

Other income, net

    49     100     175  
               

(Loss) income before income taxes

    (11,102 )   14,935     13,366  

Income tax benefit (expense)

    37     (43 )   (241 )
               

Net (loss) income

    (11,065 )   14,892     13,125  
               

Other comprehensive income

                   

Unrealized (loss) gain on investments available for sale

    (40 )   23     85  
               

Total comprehensive (loss) income

  $ (11,105 ) $ 14,915   $ 13,210  
               

Basic (loss) earnings per share

  $ (0.34 ) $ 0.45   $ 0.40  
               

Diluted (loss) earnings per share

  $ (0.34 ) $ 0.45   $ 0.40  
               

Weighted average common shares (basic)

    32,859     32,820     32,784  
               

Weighted average common shares (diluted)

    32,859     33,118     33,097  
               

   

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

72


Table of Contents


OSIRIS THERAPEUTICS, INC.

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(amounts in thousands, except for share and per share data)

 
  Common Stock    
  Accumulated
Other
Comprehensive
(Loss) Income
   
   
 
 
  Additional
Paid-in
Capital
  Accumulated
Deficit
  Total
Stockholders'
Equity
 
 
  Shares   Amount  

Balance at January 1, 2010

    32,773,331   $ 33   $ 272,959   $ (88 ) $ (260,344 ) $ 12,560  

Exercise of options to purchase common stock ($.40 per share)

    8,626         3             3  

Share-based payment—director services ($6.46 per share)

    11,500         74             74  

Share-based payment—employee compensation

            1,610             1,610  

Net income

                    13,125     13,125  

Unrealized gain on investments available for sale

                85         85  
                           

Balance at December 31, 2010

    32,793,457   $ 33   $ 274,646   $ (3 ) $ (247,219 ) $ 27,457  

Exercise of options to purchase common stock ($.40-$7.74 per share)

    9,064         22             22  

Share-based payment—director services ($7.13 per share)

    25,000         178             178  

Share-based payment—employee compensation

            1,506             1,506  

Share-based payment—related party

            1,740             1,740  

Net income

                    14,892     14,892  

Unrealized gain on investments available for sale

                23         23  
                           

Balance at December 31, 2011

    32,827,521   $ 33   $ 278,092   $ 20   $ (232,327 ) $ 45,818  

Exercise of options to purchase common stock ($.40-$7.74 per share)

    28,708         87             87  

Share-based payment—director services ($5.08 per share)

    25,000         127             127  

Share-based payment—employee compensation

            963             963  

Net loss

                    (11,065 )   (11,065 )

Unrealized loss on investments available for sale

                (40 )       (40 )
                           

Balance at December 31, 2012

    32,881,229   $ 33   $ 279,269   $ (20 ) $ (243,392 ) $ 35,890  
                           

   

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

73


Table of Contents


OSIRIS THERAPEUTICS, INC.

STATEMENTS OF CASH FLOWS

(amount in thousands)

 
  Year ended December 31,  
 
  2012   2011   2010  

Cash flows from operating activities:

                   

Continuing operations

                   

Net (loss) income

  $ (11,065 ) $ 14,892   $ 13,125  

Adjustments to reconcile net (loss) income to net cash used in continuing operations:

                   

Depreciation and amortization

    708     745     755  

Non cash share-based payments

    1,090     1,684     1,684  

Provision for bad debts

    22     3      

Deferred tax benefit

            (3,170 )

Non cash expense- extension of expiration date of warrant to related party

        1,740      

Changes in operating assets and liabilities:

                   

Accounts receivable

    (2,357 )   1,197     (790 )

Inventory

    (511 )   (257 )   (510 )

Prepaid expenses and other current assets

    (259 )   266     212  

Deferred tax assets

    2,188     982      

Other assets

        184     211  

Accounts payable and accrued expenses

    246     (912 )   (3,403 )

Deferred revenue

    (3,333 )   (40,960 )   (40,891 )
               

Net cash used in continuing operations

    (13,271 )   (20,436 )   (32,777 )
               

Discontinued operations

                   

Changes in operating assets and liabilities:

                   

Accounts payable and accrued expenses

            (412 )
               

Net cash used in discontinued operations

            (412 )
               

Net cash used in operating activities

    (13,271 )   (20,436 )   (33,189 )
               

Cash flows from investing activities:

                   

Purchases of property and equipment

    (128 )   (81 )   (148 )

Proceeds from sale of investments available for sale

    13,500     20,805     33,598  

Purchases of investments available for sale

    (48 )   (220 )   (270 )
               

Net cash provided by investing activities

    13,324     20,504     33,180  
               

Cash flows from financing activities:

                   

Principal payments on capital lease obligations

    (22 )       (3 )

Restricted cash

    75     129     145  

Proceeds from the issuance of common stock, net

    87     22     3  
               

Net cash provided by financing activities

    140     151     145  
               

Net increase in cash

    193     219     136  

Cash at beginning of period

    1,661     1,442     1,306  
               

Cash at end of period

  $ 1,854   $ 1,661   $ 1,442  
               

Supplemental disclosure of cash flows information:

                   

Cash paid for income taxes

  $   $   $ 4,281  

Supplemental disclosure of non cash activities:

                   

Equipment acquired under a capital lease

    228          

   

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

74


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies

Description of Business

        Osiris Therapeutics, Inc. ("we," "us," "our," or the "Company") is a Maryland corporation headquartered in Columbia, Maryland. We began operations on December 23, 1992 and were a Delaware corporation until, with approval of our stockholders, we reincorporated as a Maryland corporation on May 31, 2010. We are a leading stem cell company focused on developing and marketing products to treat serious medical conditions in the inflammatory, cardiovascular, orthopedic, and wound healing markets.

        We have two business segments, Therapeutics and Biosurgery. Our Therapeutics business is focused on developing biologic stem cell drug candidates from a readily available and non-controversial source—adult bone marrow. Our biologic drug candidates utilize adult human mesenchymal stem cells, or MSCs, which can selectively differentiate, based on the tissue environment, into various tissue lineages, such as muscle, bone, cartilage, marrow stroma, tendon or fat. In addition, MSCs have anti-inflammatory properties and can prevent fibrosis or scarring, which gives MSCs the potential to treat a wide variety of medical conditions. Our Biosurgery business, which we created in 2009 and has operated as a separate segment since 2010, focuses on products for orthopedics and wound healing and use in surgical procedures to harness the ability of cells and novel constructs to promote the body's natural healing.

        Historically, our operations have consisted primarily of research, development and clinical activities under several research collaboration agreements to bring our biologic drug candidates to the marketplace. During the second quarter of 2012, we received authorization from Health Canada to market our stem cell therapy Prochymal® (remestemcel-L), for the treatment of refactory acute graft-vs-host disease (GvHD) in children. This was the first marketing approval for one of our biologic drug candidates, and marks the world's first regulatory approval of a manufactured stem cell therapeutic product and the first therapy approved for GvHD. Subsequent to the approval by Health Canada, we have also been granted marketing consent for Prochymal for the same indication in New Zealand. We expect to commence commercial distribution in the near future.

        Our Biosurgery business has continued to grow since its inception in 2009, and we anticipate continuing to increase our organizational focus on the development and commercialization of products in this segment as the revenues generated from Bisourgery products increase in the foreseeable future.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Due to the inherent uncertainty involved in making those assumptions, actual results could differ from those estimates. We believe that the most significant estimates that affect our financial statements are those that relate to deferred tax assets, inventory valuation, share-based compensation, and the non cash charge associated with the extension of the expiration date of an outstanding warrant discussed below in Note 9.

75


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

Cash and Cash Equivalents

        Amounts listed as cash on our balance sheets are maintained in depository accounts at a commercial bank. Cash and cash equivalents, which include highly liquid investments with maturities of three months or less when purchased, held in our brokerage investment accounts are classified as investments available for sale, as the amounts represent investments that have matured and are anticipated to be reinvested in debt securities in the near future, and are disclosed at fair value, which approximates cost.

Reclassifications

        We have reclassified certain prior-year amounts for comparative purposes. These reclassifications did not affect our results of operations or financial positions for the years presented.

Investments Available for Sale

        Investments available for sale consist primarily of marketable securities with maturities less than one year. Investments available for sale are valued at their fair value, with unrealized gains and losses reported as a separate component of stockholders' equity in accumulated other comprehensive income. All realized gains and losses on our investments available for sale are recognized in results of operations as other income.

        Investments available for sale are evaluated periodically to determine whether a decline in their value is "other than temporary." The term "other than temporary" is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security. We review criteria such as the magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. If a decline in value is determined to be other than temporary, the carrying value of the security is reduced and a corresponding charge to earnings is recognized.

Restricted Cash

        We periodically are required under the terms of various agreements to provide letters of credit which are collaterialized by cash deposits. The majority of the restricted cash balance relates to a letter of credit that we caused to be issued in lieu of a security deposit under the operating lease for our Columbia, Maryland facility.

Accounts Receivable

        Accounts receivable are reported at their net realizable value. We charge off uncollectible receivables when the likelihood of collection is remote. We set credit terms with individual customers, and consider receivables outstanding longer than the time specified in the respective customer's contract, typically 45-days, to be past due. As of December 31, 2012 and 2011, accounts receivable in the accompanying balance sheet are reported net of a $25,000 and a $3,000 allowance for doubtful accounts, respectively. We believe the reported amounts are fully collectible. Accounts receivable balances are not collateralized. We have incurred bad debt expense of $22,000 and 3,000 related to our

76


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

biosurgery operations during fiscal 2012 and 2011, respectively, and no bad debts expense during the year ended December 31, 2010.

Inventory

        We began carrying inventory of our Biosurgery products on our balance sheet following commercial launch of such products. Inventory consists of raw materials, biologic products in process, and products available for distribution. We determine our inventory values using the first-in, first-out method. Inventory is valued at the lower of cost or market, and excludes units that we anticipate distributing for clinical evaluation.

        We do not currently carry any inventory for our Therapeutics products, as we have yet to launch Prochymal for commercial distribution following its approval in Canada during the second quarter of 2012, and subsequent approval in New Zealand. Historically, our Therapeutics segment operations have focused on clinical trials and discovery efforts, and accordingly, manufactured clinical doses of our drug candidates were expensed as incurred, consistent with our accounting for all other research and development costs. Once we begin commercial distribution, all newly manufactured Prochymal doses will be allocated either for use in commercial distribution, which will be carried as inventory and not expensed, or for research and development efforts, which will continue to be expensed as incurred.

Property and Equipment

        Property and equipment, including improvements that extend useful lives, are valued at cost, while maintenance and repairs are charged to operations as incurred. Depreciation is calculated using the straight-line method based on estimated useful lives ranging from three to seven years for furniture, equipment and internal use software. Leasehold improvements and assets under capital leases are amortized over the shorter of the estimated useful life of the asset or the original term of the lease.

Valuation of Long-lived Assets

        We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. Assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized for the difference between the fair value and carrying value of assets. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. There were no impairment losses recognized during fiscal years 2012, 2011 or 2010.

77


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

Revenue Recognition

        As discussed in Note 3—Segment Reporting below, in 2010 we began operations of our Biosurgery segment, focused on developing high-end biologic products for use in wound healing and surgical procedures. We commenced the manufacturing of our first Biosurgery product, Grafix®, a regenerative wound care product, during the first quarter of 2010. During the first and second quarters of 2010, we distributed the product only for initial clinical evaluation. We launched the product for limited commercial distribution during the third quarter of 2010. We began distribution of a second Biosurgery product, Ovation® in early fiscal 2011, and continued to increase our distribution volume throughout fiscal 2011 and 2012. We recognized revenues of $7.8 million and $1.3 million on distribution of our Biosurgery products in 2012 and 2011, respectively, compared to $183,000 subsequent to commercial launch in fiscal 2010.

        Legal title passes to the customers when the product leaves our shipping dock. We recognize revenue when persuasive evidence of an arrangement exists, the product has been shipped, the price to the buyer is fixed or determinable, and collectability is reasonably assured. As such, substantially all revenue and costs of revenue are recognized when legal title passes. Due to the nature of the products and the manufacturing process, we do not allow sales returns or refunds.

        To date, our Therapeutics segment has generated revenues primarily from collaborative agreements and research licenses. We evaluate revenues from agreements that have multiple elements to determine whether the components of the arrangement represent separate units of accounting. To recognize a delivered item in a multiple element arrangement, the delivered items must have value on a standalone basis and the delivery or performance must be probable and within our control for any delivered items that have a right of return. The determination of whether multiple elements of a collaboration agreement meet the criteria for separate units of accounting requires us to exercise judgment.

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

        In October 2008, we entered into a Collaboration Agreement with Genzyme Corporation, then an independent and now a Sanofi company ("Genzyme"), for the development and commercialization of our biologic drug candidates, Prochymal and Chondrogen™. Under this agreement, Genzyme made non-contingent, non-refundable cash payments to us, totaling $130.0 million. The agreement provided Genzyme with certain rights to intellectual property developed by us, and required that we continue to perform certain development work related to the subject biologic drug candidates. In February 2012, Sanofi issued a press release which included an update on their R&D pipeline, stating that it had discontinued its project with Prochymal for GvHD. In September 2012, we reached agreement with Sanofi to conclude the Collaboration Agreement without either party having any continuing obligation

78


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

to the other. We are continuing to proceed with our Prochymal regulatory approval and commercialization efforts.

        We evaluated the deliverables related to the upfront payments made to us under the Genzyme collaboration agreement, and concluded that the various deliverables represent a single unit of accounting. For this reason, we deferred the recognition of revenue related to the upfront payments, and amortized these amounts to revenue on a straight-line basis over the estimated delivery period of the required development services, which extended through January 2012.

        Accordingly, we recognized $3.3 million of revenue from this agreement during 2012, all of which came during the first fiscal quarter corresponding with the estimated end point date in January of 2012, compared to $40.0 million of revenue in each of the years ended December 31, 2011 and 2010 related to the amortization of the upfront payments.

        In 2007, we also partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the United States Department of Defense ("DoD") pursuant to which we sought, in partnership with Genzyme, to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from acute radiation exposure. We began recognizing revenue under this contract in 2008, and completed our work under the contract during 2010. Contract revenue was recognized as the related costs were incurred, in accordance with the terms of the contract. We recognized approximately $470,000 in revenue from the DoD contract during 2010. We did not recognize any revenue associated with this contract during fiscal 2012 or 2011.

        In October 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation ("JDRF") to conduct a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes mellitus. This collaborative agreement provided for JDRF to provide up to $4.0 million of contingent milestone funding to support the development of Prochymal for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. The contingent milestone payments under the agreement were amortized to revenue on a straight line basis over the duration of our obligations under the collaborative agreement as they were received and earned. We have received all $4.0 million of the contingent milestones, and amortized the funding received over the duration of our obligations. We substantially completed our work under this contract in fiscal 2011, resulting in $1.0 million in revenue during 2011 compared to $1.2 million of revenue during 2010. We did not recognize any revenue associated with this contract during fiscal 2012.

        We have also entered into strategic agreements with other pharmaceutical companies focusing on the development and commercialization of our stem cell drug candidates. For example, in 2003, we entered into an agreement with JCR Pharmaceuticals Co., Ltd. ("JCR") pertaining to hematologic malignancies (GvHD) drugs for distribution in Japan. Under such agreements, we receive fees for licensing the use of our technology. We recognized $1.0 million of revenue during the first fiscal quarter of 2010 from JCR upon the achievement of a milestone event specified in the agreement.

        Our Therapeutics segment also earns royalty revenues and cost reimbursement under our adult expanded access program. Royalties are earned on the sale of human mesenchymal stem cells sold for research purposes. We recognize this revenue as sales are made. Revenues include approximately $305,000 of royalty revenue in 2012, $65,000 of royalty revenue in 2011 and $300,000 of royalty revenue

79


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

in 2010. Revenues also include approximately $296,000, $115,000, and $41,000 in cost reimbursement for Prochymal used in our adult expanded access program during 2012, 2011, and 2010, respectively.

    Research and Development Costs

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

        Beginning with the creation of our Biosurgery segment, we began to separately track research and development costs by segment. Total research and development costs for each of our operating segments are as follows:

 
  2012
($000s)
  2011
($000s)
  2010
($000s)
 
 
  Therapeutics   Biosurgery   Total   Therapeutics   Biosurgery   Total   Therapeutics   Biosurgery   Total  

Research and development costs

  $ 9,573   $ 4,535   $ 14,108   $ 15,829   $ 3,327   $ 19,156   $ 19,102   $ 4,399   $ 23,501  

        Internal resources are applied interchangeably across several product candidates due to the potential applicability of our biologic drug candidates for multiple indications. We do, however, track external research and development costs on a project basis. Our external research and development costs, including third party contract costs, supply and lab costs, and other miscellaneous external costs, for the years ended December 31, 2012, 2011 and 2010 are as follows:

 
  Year Ended December 31,  
 
  2012
($000s)
  2011
($000s)
  2010
($000s)
 

External R&D Costs By Indication

                   

Acute myocardial infarction

  $ 2,020   $ 6,254   $ 4,082  

Treatment-resistant GvHD

    680     830     2,759  

Refractory Crohn's disease

    752     1,437     905  

Other therapeutic programs

    562     400     2,580  
               

Therapeutics external R&D costs—

    4,014     8,921     10,326  
               

Diabetic foot ulcer

    1,169          

Other biosurgery programs

    76     1,151     1,779  
               

Biosurgery external R&D costs—

    1,245     1,151     1,779  
               

Total External R&D Costs—

  $ 5,259   $ 10,072   $ 12,105  
               

Income Taxes

        Deferred tax liabilities and assets are recognized for the estimated future tax consequences of temporary differences, income tax credits and net operating loss carry-forwards. Temporary differences are primarily the result of the differences between the tax bases of assets and liabilities and their financial reporting values. Deferred tax liabilities and assets are measured by applying the enacted

80


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

statutory tax rates applicable to the future years in which deferred tax liabilities or assets are expected to be settled or realized. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense, if any, consists of the taxes payable for the current period and the change during the period in deferred tax assets and liabilities.

        We recognize in our financial statements the impact of a tax position, if that position is more likely than not to be sustained upon an examination, based on the technical merits of the position. Interest and penalties related to income tax matters are recorded as income tax expense. At December 31, 2012 and 2011, we had no accruals for interest or penalties related to income tax matters.

Income per Common Share

        Basic income per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per common share adjusts basic income per share for the potentially dilutive effects of common share equivalents, using the treasury stock method, and includes the incremental effect of shares that would be issued upon the assumed exercise of stock options and warrants.

        Diluted loss per common share for the year ended December 31, 2012 excludes the 1,000,000 shares issuable upon the exercise of an outstanding "out-of the money" warrant, and all 1,826,114 of our outstanding options as of December 31, 2012, as their impact on our net loss is anti-dilutive. As a result, basic and diluted weighted average common shares outstanding are identical.

        Diluted income per common share for 2011 excludes 1,311,686 "out-of the money" stock options and the 1,000,000 shares issuable upon the assumed exercise of our outstanding warrant, discussed in Note 8 below, as their effect is anti-dilutive. Similarly, diluted income per common share for 2010 excludes 824,909 "out-of the money" stock options and the 1,000,000 shares issuable upon the assumed exercise of our outstanding warrant, as their effect is anti-dilutive.

        A reconciliation of basic to diluted weighted average common shares outstanding is as follows:

 
  Year Ended December 31,  
 
  2012   2011   2010  
 
  (000s)
  (000s)
  (000s)
 

Basic weighted average common shares outstanding

    32,859     32,820     32,784  

Dilutive weighted average options outstanding

        298     313  

Dilutive weighted average warrants outstanding

             
               

Diluted weighted average common shares outstanding

    32,859     33,118     33,097  
               

Share-Based Compensation

        We account for share-based payments using the fair value method.

        We recognize all share-based payments to employees and non-employee directors in our financial statements based on their grant date fair values, calculated using the Black-Scholes option pricing model. Compensation expense related to share-based awards is recognized on a straight-line basis for

81


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

1. Description of Business and Significant Accounting Policies (Continued)

each vesting tranche based on the value of share awards that are expected to vest on the grant date, which is revised if actual forfeitures differ materially from original expectations.

Comprehensive Income

        Comprehensive income consists of net income and all changes in equity from non-stockholder sources, which consist of changes in unrealized gains and losses on investments.

Concentration of Risk

        We maintain cash and short-term investment balances in accounts that exceed federally insured limits, although we have not experienced any losses on such accounts. We also invest excess cash in investment grade securities, generally with maturities of one year or less.

        We have historically provided credit in the normal course of business to contract counterparties and to the distributors of our product. Accounts receivable in the accompanying balance sheets consist primarily of amounts due from distributors of our Biosurgery products within the United States. During fiscal 2012, revenues from one of the distributors of our Biosurgery products, PhysioRx, comprised approximately 60% of our total Biosurgery revenues. As of December 31, 2012, receivables from this distributor comprised a similar percentage of our total receivables. We expect all of our reported receivables to be fully collected. As discussed under "Accounts Receivable" above, we have not incurred material bad debt expense for the three years ended December 31, 2012.

Recent Accounting Guidance Not Yet Adopted at December 31, 2012

        We have considered the applicability and impact of all Financial Standards Board's Accounting Standards Updates ("ASUs"). Recently issued ASUs were evaluated and determined not to be applicable in this Annual Report on Form 10K.

2. Collaboration Agreements and Government Contract

        Following is a discussion of each of our material collaborative agreements and contracts. The accounting policies related to each of these contracts, including material impact on our financial statements, is included above under the "Revenue Recognition" section of Note 1, Description of Business and Significant Accounting Policies.

        Collaboration Agreement with Genzyme Corporation.    On October 31, 2008, we entered into a Collaboration Agreement with Genzyme for the development and commercialization of Prochymal and Chondrogen. As consideration for the rights originally granted to Genzyme under the Collaboration Agreement, they paid us non-contingent, non-refundable cash payments totaling $130.0 million.

        On September 28, 2012, we announced the conclusion of our collaboration with Genzyme, a Sanofi company. As a result, all rights to Prochymal and Chondrogen worldwide revert back to us, and we are now free to commercialize or enter into commercialization agreements for Prochymal and Chondrogen with others without limitation. Both parties agreed to an orderly conclusion of the collaboration, with no further financial responsibilities for either party, and an amicable end to the relationship.

82


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

2. Collaboration Agreements and Government Contract (Continued)

        Genzyme Partnership and the United States Department of Defense Contract.    In 2007, we also partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the DoD pursuant to which we, in partnership with Genzyme, sought to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from acute radiation exposure. We began recognizing revenue under this contract in fiscal 2008 and completed our work under the contract during 2010. The agreement with Genzyme expired in July 2010.

        Juvenile Diabetes Research Foundation Agreement.    In 2007, we entered into a collaborative agreement with the JDRF which provides funding to support the development of Prochymal as a treatment for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. This collaborative agreement provided for JDRF to provide $4.0 million of contingent milestone funding. We initiated a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes in the fourth quarter of 2007, and achieved $2.0 million of the contingent milestones during 2008, $1.5 million in 2009, and the remaining $0.5 million in 2010. Consistent with our revenue recognition policies for such contingent milestones, we began amortizing each milestone payment as it was received and amortized the payments over the term of our obligations under the agreement in fiscal 2011. We substantially completed our work under this contract in fiscal 2011, and did not recognize any revenue associated with this contract during fiscal 2012.

        JCR Pharmaceuticals Agreement.    In 2003, we entered into a strategic alliance with JCR Pharmaceuticals Co. Ltd. ("JCR"). Under the JCR agreement, we have granted to JCR the exclusive right in Japan to use our technology in conjunction with the treatment of hematologic malignancies using hematopoietic stem cell transplants. The JCR agreement entitles us to a licensing fee and to royalties on any resulting revenue. They have paid us a total of $5.0 million in licensing fees under the agreement, $1.0 million in 2010 and $4.0 million of which was prior to 2008. The JCR agreement also provides for additional contingent milestone payments totaling $5.5 million, which will be recorded as revenue if and when the milestone events occur, and as well as royalty payments on sales of the drug in Japan.

3. Segment Reporting

        We manage our business in two reportable operating segments: the Therapeutics segment and the Biosurgery segment.

        Our Therapeutics segment focuses on developing and marketing products to treat medical conditions in the inflammatory and cardiovascular disease areas. Its operations have focused on clinical trials and discovery efforts to identify additional medical indications. Revenues for our Therapeutics segment have historically consisted primarily of collaborative research agreements and royalties as described in Note 1—Description of Business and Significant Accounting Policies. As discussed above under Note 1, Nature of Business, during the second quarter of 2012, we received authorization to market our stem cell therapy Prochymal in both Canada and New Zealand. We expect to begin commercial distribution of Prochymal in Canada and New Zealand in the near future.

        Our Biosurgery segment is focused on the development, manufacture and distribution of biologic products for orthopedic, wound healing, and surgical procedures by harnessing the ability of cells and

83


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

3. Segment Reporting (Continued)

novel constructs to promote the body's natural healing. We commenced the manufacturing of our first Biosurgery product, a regenerative wound care product, during the first quarter of 2010. During the first and second quarters of 2010, we distributed the product only for initial clinical evaluation. Accordingly, we incurred research, development, manufacturing, general, and administrative costs related to the Biosurgery segment throughout 2010, but did not recognize revenue from these products until beginning in the third quarter of 2010. As a result of these start up costs, 2010 operating results from our Biosurgery segment do not reflect the segment's recurring operations.

        Substantially all of our revenues and assets are attributed to and are received from entities located in the United States. This may change after commercial distribution of Prochymal begins in Canada and New Zealand.

        At this time, only revenues, costs of goods sold, and operating expenses are allocated by segment. The costs specifically attributable to each of our segments for the years ended December 31, 2012, 2011 and 2010 are as follows:

 
  2012
($000s)
  2011
($000s)
  2010
($000s)
 
 
  Therapeutics   Biosurgery   Total   Therapeutics   Biosurgery   Total   Therapeutics   Biosurgery   Total  

Product revenues

  $   $ 7,849   $ 7,849   $   $ 1,263   $ 1,263   $   $ 183   $ 183  

Cost of product revenues

        2,551     2,551         531     531         62     62  
                                       

Gross profit

        5,298     5,298         732     732         121     121  
                                       

Revenue from collaborative research agreements, government contract and royalties

    3,955         3,955     41,140         41,140     43,021         43,021  

Operating expenses:

                                                       

Research and development

    9,573     4,535     14,108     15,829     3,327     19,156     19,102     4,399     23,501  

General and administrative expenses and fees

    3,893     2,403     6,296     7,081     800     7,881     5,809     641     6,450  
                                       

    13,466     6,938     20,404     22,910     4,127     27,037     24,911     5,040     29,951  
                                       

(Loss) income from operations

  $ (9,511 ) $ (1,640 ) $ (11,151 ) $ 18,230   $ (3,395 ) $ 14,835   $ 18,110   $ (4,919 ) $ 13,191  
                                       

        We manage our business based on the operating results of each segment, but in general, our total assets, including long-lived assets such as property and equipment, and our capital expenditures are not specifically allocated to any particular operating segment. Accordingly, capital expenditures and total asset information by reportable segment is not presented. The only assets that are allocated to the individual segments are the inventory and accounts receivable specifically related to each segment.

84


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

3. Segment Reporting (Continued)

        The assets specifically attributable to each of our segments as of December 31, 2012 and 2011 are as follows:

 
  2012
($000s)
  2011
($000s)
 
 
  Therapeutics   Biosurgery   Total   Therapeutics   Biosurgery   Total  

Segment assets:

                                     

Accounts Receivable

  $ 209   $ 2,854   $ 3,063   $ 37   $ 691   $ 728  

Inventory

        1,278     1,278         767     767  
                           

Total segment assets

  $ 209   $ 4,132   $ 4,341   $ 37   $ 1,458   $ 1,495  
                           

4. Property and Equipment

        Property and equipment at December 31, 2012 and 2011 are as follows:

 
  2012
($000)
  2011
($000)
 

Laboratory and manufacturing equipment

  $ 532   $ 427  

Computer hardware, furniture and fixtures

    569     546  

Leased assets

    228     26  

Leasehold improvements

    4,233     4,233  
           

    5,562     5,232  

Accumulated depreciation and amortization

    (3,451 )   (2,769 )
           

Property and equipment, net

  $ 2,111   $ 2,463  
           

        We disposed of the $26,000 of leased equipment that was reported as of December 31, 2011 during fiscal 2012. This equipment had been fully amortized.

5. Inventory

        We began carrying inventory of our Biosurgery products on our balance sheet following commercial launch of such products.

        As of December 31, 2012 and 2011, inventory for our Biosurgery segment consists of the following:

 
  December 31,  
 
  2012   2011  
 
  ($000)
  ($000)
 

Inventory

             

Raw materials and supplies

  $ 284   $ 184  

Work-in-process

    135     45  

Finished goods

    971     812  

Units for clinical evaluation

    (112 )   (274 )
           

Total Biosurgery inventory

  $ 1,278   $ 767  
           

85


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

5. Inventory (Continued)

        We do not currently carry any inventory for our Therapeutics products, as we have yet to launch Prochymal for commercial distribution following its approval in Canadaduring the second quarter of 2012, and subsequent approval in New Zealand.

6. Capital Lease

        In July 2012, we leased equipment under a capital lease at an effective interest rate of approximately 5%, with 60 monthly payments of $4,000 starting July 2012. The capital lease is recorded at the present value of the future minimum lease payments. Future minimum lease payments under the capital lease agreement at December 31, 2012 are as follows:

 
  Amount
(000s)
 

2013

  $ 48  

2014

    48  

2015

    48  

2016

    48  

2017

    24  
       

    216  

Less: Amount representing interest

    (10 )
       

Present value of minimum lease payments

    206  

Less: Current portion of capital lease obligations

    (44 )
       

Long-term portion of capital lease obligations

  $ 162  
       

7. Share-Based Compensation

        In April 2006, we adopted our 2006 Omnibus Plan. We amended and restated this plan in 2008, 2010, and again in 2012 to, among other things, increase the number of shares available for grant. In addition, we had previously established our Amended and Restated 1994 Stock Incentive Plan. Both Plans authorize the issuance of various forms of stock-based awards, including incentive and non-qualified stock options, stock purchase rights, stock appreciation rights and restricted and unrestricted stock awards. A total of 2,250,000 shares of our common stock have been reserved for issuance under the Amended and Restated 2006 Omnibus Plan, and 736,378 shares were reserved under our Amended and Restated 1994 Stock Incentive Plan. We ceased all grants under the Amended and Restated 1994 Stock Incentive Plan concurrent with our initial public offering in August 2006. As a result, no shares are currently available for future awards under the Amended and Restated 1994 Stock Incentive Plan. At December 31, 2012, there were approximately 543,000 shares available for future awards under the Amended and Restated 2006 Omnibus Plan.

        We generally issue stock option awards that vest over four years and have a ten-year contractual life. We estimate the fair value of stock options using the Black-Scholes option-pricing model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized

86


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

7. Share-Based Compensation (Continued)

by persons who receive equity awards. The fair value of stock options granted during each of the periods was estimated using the following assumptions:

 
  Years ended December 31,  
 
  2012   2011   2000  

Assumptions:

                   

Weighted average risk-free interest rate

    2.00 %   2.00 %   2.50 %

Dividend yield

    0.0 %   0.0 %   0.0 %

Expected life of option grants

    6.0-6.3 yrs     5.5 yrs     5.0 yrs  

Weighted average expected stock price volatility

    52-54 %   53-55 %   56-57 %

        The expected life of stock options granted was based on the our historical option exercise experience and post vesting forfeiture experience using the historical expected term from the vesting date. The expected volatility of the options granted was determined using historical volatilities based on stock prices over a look-back period corresponding to the expected life. The risk-free interest rate was determined using the yield available for zero-coupon United States government issues with a remaining term approximating the expected life of the options. The forfeiture rate was determined based on historical pre-vesting forfeitures. We have never paid a dividend, and as such, the dividend yield is zero.

        In connection with the stock options exercised during the year ended December 31, 2012, we received cash proceeds of $87,000. At December 31, 2012, there was $0.8 million of total unrecognized compensation costs related to non-vested stock options, which is expected to be recognized over a weighted average period of approximately 1 year.

        A summary of stock option activity for the years ended December 31, 2012, 2011 and 2010 is as follows:

 
  Number of
Shares
  Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual Life
  Aggregate
Intrinsic Value
(in thousands)
 

Outstanding at January 1, 2010

    1,000,762   $ 10.78   7.0-years        

Granted

    406,500   $ 7.37            

Exercised

    (8,626 ) $ (0.40 )     $ 58  

Forfeited or canceled

    (49,375 ) $ (12.53 )          
                       

Balance, December 31, 2010

    1,349,261   $ 9.75   6.9-years        

Granted

    450,000   $ 6.82            

Exercised

    (9,064 ) $ (2.42 )     $ 36  

Forfeited or canceled

    (88,125 ) $ (8.89 )          
                       

Balance, December 31, 2011

    1,702,072   $ 9.06   6.8-years        

Granted

    302,000   $ 5.53            

Exercised

    (28,708 ) $ (3.05 )     $ 114  

Forfeited or canceled

    (149,250 ) $ (7.20 )          
                       

Balance, December 31, 2012

    1,826,114   $ 8.72   6.1-years   $ 4,754  
                       

Exercisable at December 31, 2012

    1,117,426   $ 9.79   4.7-years   $ 3,049  
                       

87


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

7. Share-Based Compensation (Continued)

        A summary of stock options outstanding at December 31, 2012, by price range is as follows:

 
  Options Outstanding   Options Exercisable  
Range of Exercise Prices
  Number
Outstanding
  Weighted-Average
Remaining
Contractual Life
(in years)
  Weighted-Average
Exercise
Price
  Number
Outstanding
  Weighted-Average
Exercise Price
 

$  0.40 to $  1.00

    290,864     2.1   $ 0.40     290,864   $ 0.40  

    1.01 to    6.75

    397,000     8.2     5.48     76,250     6.30  

    6.76 to  10.00

    569,500     7.5     7.47     222,062     7.41  

  10.01 to  12.50

    216,750     5.1     12.02     212,250     12.06  

  12.51 to  15.00

    54,000     5.3     13.59     49,000     13.66  

  15.01 to  17.50

    55,500     5.7     17.00     55,500     17.00  

  17.51 to  20.00

    124,500     6.1     18.58     93,500     18.58  

$20.01 to $24.00

    118,000     4.1     23.62     118,000     23.62  
                             

    1,826,114     6.1   $ 8.72     1,117,426     9.79  
                             

        The weighted fair value of options granted during the years ended December 31, 2012, 2011, and 2010 were $2.84, $3.50, and $3.77, respectively.

        The table below reflects the total share-based compensation expense (including share-based payments to our non-employee directors, but excluding the non cash expense related to the extension of the expiration date of an outstanding warrant as discussed in Note 8 below) recognized in our income statements for the years ended December 31, 2012, 2011 and 2010.

 
  Year ended December 31,  
 
  2012
($000)
  2011
($000)
  2010
($000)
 

Research and development

  $ 627   $ 814   $ 896  

General and administrative

    463     870     788  
               

Share-based compensation

  $ 1,090   $ 1,684   $ 1,684  
               

8. Related Party Transactions

        Peter Friedli.    Peter Friedli, the Chairman of our Board of Directors, or entities with which he is affiliated, have been responsible for procuring since 1993, an aggregate of approximately $270 million in debt and equity financing for us and our predecessor company. Mr. Friedli is the beneficial owner of approximately 43% of our common stock as of December 31, 2012. Of the shares beneficially owned by Mr. Friedli at December 31, 2012, 65,000 shares were received by him as Board compensation since 1996, 12,500 shares and warrants for 1,000,000 shares were granted in recognition of his fundraising efforts, as discussed below, and the remaining shares were acquired through investment or through purchase from third parties.

        In 2012, we issued 10,000 shares of our common stock, valued at approximately $51,000 to Mr. Friedli for his service on our Board of Directors and in 2011, we issued 10,000 shares of our

88


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

8. Related Party Transactions (Continued)

common stock, valued at $71,000 to Mr. Friedli for his service on our Board of Directors. During 2010, we paid Mr. Friedli $64,600 for his service on our Board of Directors.

        In response to Mr. Friedli's successful efforts in procuring for us accommodations relative to financing transactions that had occurred prior to our initial public offering, we issued to Mr. Friedli in 2006, in connection with and just prior to our initial public offering, a warrant exercisable for up to 1,000,000 shares of our common stock at $11.00 per share, the price for which shares were sold in the initial public offering. This warrant was scheduled to expire in May 2011.

        In light of Mr. Friedli's unwavering support of the Company over a period of many years, and in recognition of his invaluable contributions to us, as founder, as a director and as Chairman of our Board, and to encourage his continued support, our Board of Directors and Compensation Committee, by the unanimous vote of all independent and disinterested members of each, approved the extension of the expiration date of the warrant until May 24, 2015, subject to the approval of our stockholders. Our stockholders approved the extension of the warrant at our 2011 Annual Meeting of Stockholders, on May 26, 2011.

        We incurred a non cash charge against earnings on account of the extension of the warrant expiration date, based on its increase in fair value of approximately $1.7 million. This amount was recorded within general and administrative expenses. The increase in value was computed using the Black-Scholes option pricing model with a risk free interest rate of 1.50%, a 4 year increase in the expected life of the warrant, and a historical volatility of approximately 51%.

        Prolexys Pharmaceuticals, Inc.    During the third quarter of fiscal 2011 we entered into a contract research agreement with Prolexys Pharmaceuticals, Inc. under which we are conducting for Prolexys an early stage clinical trial investigating a novel compound as a product candidate for cancer therapeutics. This contract was filed as an exhibit to and discussed in a Current Report on Form 8-K filed by us with the SEC primarily because of the related nature of the management and ownership of Prolexys with us and our management and with certain of our significant stockholders, and not because our rights or obligations under the contract research agreement with Prolexys are otherwise material to us. We are not incurring any third party costs related to our work with Prolexys and are primarily contributing only the efforts of employees. All third party costs associated with the Prolexys study are paid directly by Prolexys. As of December 31, 2012, the amount of internal resources we have devoted to Prolexys is not material to our operations as a whole

        Prolexys is 35.7% owned by BIH SA, which owns 8.2% of our outstanding common stock; 24.3% owned by Peter Friedli who is the Chairman of our Board of Directors and direct owner of 29.3% of our common stock; and 13.8% owned by Venturetec, Inc., which holds 12.5% of our common stock. Peter Friedli is the President and a 3% owner of Venturetec, Inc. Lode Debrabandere, our Chief Operating Officer, serves on the Board of Directors of Prolexys, but has no other interest therein.

        This arrangement is part of our ongoing efforts to expand our portfolio of product candidates, but we do not consider this arrangement to be material to us at this time.

        Our Board of Directors and Audit Committee, including all of our independent directors, but with Mr. Friedli abstaining, unanimously approved this transaction.

89


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

9. Warrants

        As discussed in Note 8 above, at December 31, 2012, we had an outstanding warrant to purchase 1,000,000 shares of our common stock at an exercise price of $11.00 per share. As of December 31, 2012, a summary of the status of the warrant is as follows:

Warrant Price
  Common Shares   Weighted Average
Remaining
Contractual Life
  Intrinsic Value   Expiration Date  
$11.00     1,000,000   3.5 years   $     May 24, 2015  

        The warrant was issued during 2006 prior to our IPO, at exercise price of $11.00, and the expiration date was extended during 2011 as discussed above. Upon approval by the stockholders, we incurred a non cash charge against earnings on account of the extension of the warrant expiration date, based on its increase in fair value of approximately $1.7 million. This amount was recorded within share based payments to related parties in the statement of operations. The increase in value was computed using the Black-Scholes option pricing model with a risk free interest rate of 1.50%, a 4 year increase in the expected life of the warrant, and a historical volatility of approximately 51%.

10. Income Taxes

        For income tax reporting purposes, we incurred a loss in fiscal 2012 and 2011. The loss in 2011 was primarily because we recognized the entire $130.0 million up-front payment made to us by Genzyme as of the end of fiscal 2010 for tax purposes. For financial reporting purposes, we recognized $40.0 million in revenue from the Genzyme payments during fiscal 2011. The $37,000 income tax benefit recognized during fiscal 2012 resulted from the true-up of our tax asset accounts upon filing our 2011 income tax returns and the $43,000 provision for income taxes during fiscal 2011 resulted from the true-up of our tax asset accounts upon filing our 2010 income tax returns.

        The provision for income taxes in 2010 represents the U.S. Federal income tax of $2.7 million, Maryland state income taxes of $1.2 million, net of the valuation allowance release of $3.2 million and the true-up of our income tax payable account to the 2009 income tax returns and is $241,000.

        The effective tax rate varies from the U.S. Federal Statutory tax rate principally due to the following:

 
  2012   2011   2010  

U.S. Federal Statutory tax rate

    35.0 %   35.0 %   35.0 %

State taxes, net of federal benefits

    5.4     5.4     5.4  

Non-deductible expenses

    9.8     9.7     1.2  

Change in valuation allowance

    (49.9 )   (50.0 )   (36.6 )

Other

    (0.3 )   0.3     (3.2 )
               

Effective tax rate

    (0.3 )%   0.3 %   1.8 %
               

        Non-deductible expenses represent primarily research and development expenses for which we claimed the orphan drug credit and non-cash share based compensation for each of the three years ended December 31, 2012.

90


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

10. Income Taxes (Continued)

        The components of our net deferred tax assets and liabilities at December 31 are as follows:

 
  2012
($000)
  2011
($000)
 

Deferred Tax Assets:

             

Net operating loss carry-forwards

  $ 14,985   $ 3,409  

Research and orphan drug credit carry-forwards

    77,374     76,253  

Alternative minimum tax credit carry-forwards

    1,194     1,194  
           

    93,553     80,856  

Valuation allowance

    (93,553 )   (78,668 )
           

Net deferred tax assets

  $   $ 2,188  
           

Deferred Tax Liabilities:

             

Deferred revenue

  $   $  
           

        During 2011, we recognized $2.2 million of our net deferred tax assets related to timing differences in the recognition of deferred revenue related to our collaboration agreement with Genzyme for financial reporting and income tax purposes, which was subsequently realized during 2012.

        We presently have available for federal income tax purposes, approximately $77.4 million of research and experimentation credit carry-forwards, which expire beginning in 2026 through 2032. In addition, we expect to have approximately $15.0 million of federal net operating loss carryforwards as of December 31, 2012, which will begin to expire in 2031. In 2010, we were subject to the alternative minimum tax. In 2012 and 2011, we were not subject to the alternative minimum tax due to having a net loss for tax purposes. In the future, we may be subject to the alternative minimum tax regardless of our net operating loss carry-forwards.

        Generally, corporations with tax attribute carryovers such as net operating losses and tax credits ("Loss Corporations") may become subject to an annual limitation as to the amount of tax attributes that may be available for use for federal income tax purposes. In general, Sections 382 and 383 of the Internal Revenue Code generally limit the annual amount of net operating loss and credit carryovers of Loss Corporations when such Loss Corporations experience an ownership change. An ownership change occurs if one or more "5-percent shareholders" increase their ownership in the Loss Corporation stock, in the aggregate, by more than 50 percentage points during a 3-year "testing period." The regulations governing the determination of a corporation's 5-percent shareholders attempt to identify the individuals who, directly or pursuant to certain attribution rules, are the beneficial owners of the Loss Corporation stock and, correspondingly, benefit from the use its tax attribute carryovers. Generally, the annual limitations are determined with reference to the value of the underlying corporation.

        We performed a limited period analysis from February 21, 2003 to December 31, 2008 and determined that we had experienced three ownership changes during this period. Accordingly, the majority of our net operating losses and all of our tax credits that were generated from our inception through February 11, 2005, the date of the last ownership change, are expected to expire unused.

91


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

10. Income Taxes (Continued)

        Effective January 1, 2007, we adopted the provisions of the accounting pronouncement clarifying the accounting for uncertain tax positions. The pronouncement prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The pronouncement also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We have evaluated our tax positions in the tax returns filed, as well as un-filed tax positions and the amounts comprising our deferred tax assets. We have determined that the pronouncement does not have a material impact on our financial condition, results of operations or cash flows

11. Defined Contribution Plan

        We have a 401(k) plan that is available to all employees. Employee contributions are voluntary and are determined on an individual basis up to the amount allowable under federal regulations. Employer contributions to the plan are at the discretion of the Board of Directors and vest over a seven year period beginning after the third year of eligibility. No employer contributions have been made to date.

12. Commitments and Contingencies

        Contract Research Organizations.    We utilize independent contract research organizations ("CROs") to perform many of the tasks required under our clinical trials of our biological drug candidates. We rely on CROs for their testing expertise and to ensure the objectivity of our clinical results. Under the terms of these agreements, we design the protocol regarding the testing to be performed, and the CRO assists in the enrollment of the patients and testing sites, administers the trial, performs statistical analysis of the results, and compiles the final report.

        We pay fees directly to the CROs for their professional services, which may be payable upon specified trial milestones or as they provide services, depending on the structure of the contract. We are also responsible for reimbursing the CROs for certain pass thru expenses they incur in administering the trial. The timing of our payments to the CROs is dependent upon the progress of the various trials, which is highly variable dependent upon the speed with which the CROs are able to enroll patients and testing sites. As such, we are unable to specifically predict the timing of future payments to CROs.

        As of December 31, 2012, we had active contracts with CROs related to three on-going clinical trials which were in varying stages of completion. The total contracted payments to CROs under these agreements were $23.9 million, of which we had incurred approximately $17.9 million as of that date. Although we cannot directly control the timing of the remaining payments, based on our estimates and assumptions as of December 31, 2012, we expect to pay $4.4 million of our remaining obligations to these CROs during 2013 and the remainder in 2014.

        Leases.    During 2006, we entered into a sublease agreement for approximately 61,000 square feet of laboratory, production, warehouse and office space in Columbia, Maryland. We have also entered into a direct lease with the owner of this facility that was effective as of June 1, 2009 upon the expiration of the sublease and expires in July 2016. During 2009, following the expiration of the sublease agreement, we increased an outstanding letter of credit, which was used in lieu of a security deposit for this lease, to $591,000 according to the terms of the direct lease with the owner of the

92


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

12. Commitments and Contingencies (Continued)

facility. At each of July 1, 2012, 2011, and 2010, the security deposit required under this lease decreased to $298,000, $372,000 and $446,000, respectively. We reduced our outstanding letter of credit accordingly, and the reduced letter of credit of $298,000 remained outstanding as of December 31, 2012, and has been fully collateralized by restricted cash.

        The future minimum lease payments due under the operating lease for this facility are as follows:

 
  Columbia
Facility
($000)
 

2013

  $ 1,137  

2014

    1,165  

2015

    1,194  

2016

    606  
       

  $ 4,102  
       

        Our expenses under this lease were $1.3 million, $1.2 million, and $1.3 million during 2012, 2011, and 2010, respectively.

        Historically, we also have entered into various financing arrangements to lease laboratory and other equipment. The terms of these facilities and equipment leases are considered capitalized leases.

        As discussed in Note 6—Capital Lease, in July 2012, we leased an additional $228,000 of equipment under a capital lease, which was included in our balance sheet at December 31, 2012 along with $23,000 of accumulated depreciation.

        Technology Transfer and License Agreement.    In 1994, we entered into a Technology Transfer and License Agreement with Case Western Reserve University ("CWRU") under which we purchased rights to certain mesenchymal stem cell and related technology and patents. We are required to pay royalties on revenues related to CWRU developed technology, with minimum royalties of $50,000 per year. We paid CWRU $50,000 in each of the years 2012, 2011, and 2010, under this agreement.

        Legal.    We are subject to certain litigation, claims and assessments which occur in the normal course of business. Based on consultation with our legal counsel, management is of the opinion that such matters, when resolved, will not have a material impact on our consolidated results of operations, financial position or cash flows.

93


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

13. Investments Available for Sale

        Investments available for sale consisted of the following as of December 31, 2012 and 2011:

 
  December 31, 2012
$000
  December 31, 2011
$000
 
 
   
  Unrealized    
   
  Unrealized    
 
 
  Cost   Gain   Loss   Fair Value   Cost   Gain   Loss   Fair Value  

Cash equivalents:

                                                 

Money market funds & certificates of deposit

  $ 2,478   $   $   $ 2,478   $ 528   $   $   $ 528  

Commercial paper & corporate securities

    4,940         (3 )   4,937     15,457     4     (1 )   15,460  
                                   

    7,418         (3 )   7,415     15,985     4     (1 )   15,988  

Investments:

                                                 

Common stock and municipal securities

    9,769     1     (3 )   9,767     1,637         (1 )   1,636  

Agency obligations

    14,871     3     (18 )   14,856                  

Corporate notes and bonds

                    26,881     16         26,897  

US & International government agencies

    200             200     1,207     2         1,209  
                                   

    24,840     4     (21 )   24,823     29,725     18     (1 )   29,742  
                                   

Investments available for sale

  $ 32,258   $ 4   $ (24 ) $ 32,238   $ 45,710   $ 22   $ (2 ) $ 45,730  
                                   

        The following table summarizes maturities of our investments available for sale as of December 31, 2012 and 2011:

 
  December 31, 2012
$000
  December 31, 2011
$000
 
 
  Cost   Fair Value   Cost   Fair Value  

Maturities:

                         

Within 3-months

  $ 7,759   $ 7,760   $ 42,727   $ 42,742  

Between 3 - 12 months

    15,227     15,221          

Between 1 - 2 years

    9,272     9,257     2,983     2,988  
                   

Investments available for sale

  $ 32,258   $ 32,238   $ 45,710   $ 45,730  
                   

        Realized gains and investment income earned on investments available for sale for the years ended December 31, 2012, 2011, and 2010, were $52,000, $100,000, and $175,000, respectively, and have been included as a component of "Other income, net" in the accompanying financial statements.

14. Fair Value

        Fair value is defined as the price at which an asset could be exchanged or a liability transferred (an exit price) in an orderly transaction between knowledgeable, willing parties in the principal or most advantageous market for the asset or liability. Where available, fair value is based on observable

94


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

14. Fair Value (Continued)

market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied.

        Financial assets recorded at fair value in the accompanying financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The levels are directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, and are as follows:

Level 1   Inputs are unadjusted, quoted prices in active markets for identical assets at the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

 

The fair valued assets we hold that are generally included in this category are money market securities where fair value is based on publicly quoted prices.

Level 2

 

Inputs are other than quoted prices included in Level 1, which are either directly or indirectly observable for the asset or liability through correlation with market data at the reporting date and for the duration of the instrument's anticipated life.

 

 

The fair valued assets we hold that are generally included in this category are investment grade short-term securities.

Level 3

 

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities and which reflect management's best estimate of what market participants would use in pricing the asset or liability at the reporting date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

 

 

We carry no investments classified as Level 3.

        When quoted prices in active markets for identical assets are available, we use these quoted market prices to determine the fair value of financial assets and classify these assets as Level 1. In other cases where a quoted market price for identical assets in an active market is either not available or not observable, we obtain the fair value from a third party vendor that uses pricing models, such as matrix pricing, to determine fair value. These financial assets would then be classified as Level 2. In the event quoted market prices were not available, we would determine fair value using broker quotes or an internal analysis of each investment's financial statements and cash flow projections. In these instances, financial assets would be classified based upon the lowest level of input that is significant to the valuation. Thus, financial assets might be classified in Level 3 even though there could be some significant inputs that may be readily available. To date, we have never had any assets that were required to be classified as Level 3.

95


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

14. Fair Value (Continued)

        Assets and liabilities measured at fair value on a recurring basis are summarized below as of December 31, 2012 and 2011:

 
  December 31, 2012
($000s)
 
 
  Level I   Level II   Level III   Total  

Assets

                         

Cash equivalents

  $ 2,478   $   $   $ 2,478  

Government obligations

        200         200  

Agency obligations

        14,856         14,856  

Corporate debt securities & commercial paper

        4,937         4,937  

Municipal securities

        9,767         9,767  
                   

Investments available for sale

  $ 2,478   $ 29,760   $   $ 32,238  
                   

 

 
  December 31, 2011
($000s)
 
 
  Level I   Level II   Level III   Total  

Assets

                         

Cash equivalents

  $ 27   $   $   $ 27  

Government obligations

    1,209             1,209  

Certificates of deposit

        501         501  

Agency obligations

        26,898         26,898  

Corporate debt securities & commercial paper

        15,459         15,459  

Municipal securities

        1,636         1,636  
                   

Investments available for sale

  $ 1,236   $ 44,494   $   $ 45,730  
                   

96


Table of Contents


OSIRIS THERAPEUTICS, INC.

NOTES TO FINANCIAL STATEMENTS (Continued)

YEARS ENDED DECEMBER 31, 2012, 2011 AND 2010

15. Quarterly Financial Data (Unaudited)

        Following is a summary of our unaudited quarterly results for the years ended December 31, 2012 and 2011:

 
  First Quarter   Second Quarter   Third Quarter   Fourth Quarter  
 
  ($000)
  ($000)
  ($000)
  ($000)
 

2012

                         

Revenues

  $ 4,583   $ 1,724   $ 2,383   $ 3,114  

Gross profit on Biosurgery revenues

    750     1,074     1,419     2,055  

Research and development expenses

    3,963     4,072     2,983     3,090  

General and administrative expenses and fees

    1,523     1,418     1,600     1,755  

Net loss

    (1,272 )   (4,265 )   (2,914 )   (2,614 )

**Net loss per share, basic and diluted

    (0.04 )   (0.13 )   (0.09 )   (0.08 )

2011

                         

Revenues

  $ 10,432   $ 10,354   $ 10,573   $ 31,359  

Gross profit on Biosurgery revenues

    22     75     192     443  

Research and development expenses

    4,711     5,209     5,018     4,218  

General and administrative expenses and fees

    1,696     3,280     1,429     1,476  

Net income

    4,039     1,792     4,013     5,048  

**Net income per share, basic and diluted

    0.12     0.05     0.12     0.15  

**
Income (loss) per share is calculated on a quarterly basis and may not be additive to year-to-date amounts.

16. Subsequent Events

        We evaluated our December 31, 2012 financial statements for subsequent events through the date the financial statements were issued. We are not aware of any subsequent events which would require recognition or disclosure in the financial statements.

97


Table of Contents


OSIRIS THERAPEUTICS, INC.

SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS

FOR THE YEARS ENDED DECEMBER 31, 2012, 2011 and 2010

(in thousands)

 
  Balance at
Beginning of
Year
  Additions   Deductions   Balance at
End of Year
 

Accounts Receivable Reserve:

                         

2012

  $ 3   $ 22   $   $ 25  

2011

        3         3  

2010

                 

Inventory Reserve:

                         

2012

  $ 274   $   $ (162 ) $ 112  

2011

    300         (26 )   274  

2010

        300         300  

Net Deferred Tax Asset Valuation Allowance: