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Osiris Therapeutics 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

o

 

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

 

For The Quarterly Period Ended September 30, 2006

 

Commission file number—001-32966

 

OSIRIS THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

71-0881115

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer Identification No.)

 

2001 Aliceanna St. Baltimore, Maryland 21231

(Address of principal executive offices) (Zip code)

 

410-522-5005

(Registrant’s telephone number, including area code)

 

None

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

 

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 x   No o

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

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

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

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

 

Class

 

 

Outstanding at November 6, 2006

Common Stock, par value $0.001 per share

 

27,306,190

 

 




OSIRIS THERAPEUTICS, INC.

INDEX

 

 

 

 

Page

 

 

 

 

 

PART I — FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements — Unaudited

 

 

 

 

Condensed Balance Sheets — September 30, 2006 and December 31, 2005

 

3

 

 

Condensed Statements of Operations — three months ended September 30, 2006 and 2005

 

4

 

 

Condensed Statements of Operations — nine months ended September 30, 2006 and 2005

 

5

 

 

Statement of Stockholders’ Equity (Deficit) — nine months ended September 30, 2006

 

6

 

 

Condensed Statements of Cash Flows — nine months ended September 30, 2006 and 2005

 

7

 

 

Notes to Condensed Financial Statements

 

8

 

 

 

 

 

Item 2.

 

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

 

13

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

17

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

18

 

 

 

 

 

PART II — OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

19

Item 1A.

 

Risk Factors

 

19

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

19

Item 3.

 

Defaults Upon Senior Securities

 

19

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

19

Item 5.

 

Other Information

 

19

Item 6.

 

Exhibits

 

20

 

 

 

 

 

Signature

 

 

 

 

 

 

 

Exhibit Index

 

 

 

2




PART I — FINANCIAL INFORMATION

Item 1.                          Financial Statements - Unaudited

OSIRIS THERAPEUTICS, INC.
Condensed Balance Sheets
Amounts in thousands

 

 

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

1,565

 

$

597

 

Short-term investments

 

51,993

 

42,774

 

Accounts receivable

 

1,008

 

974

 

Inventory and other current assets

 

1,946

 

367

 

Total current assets

 

56,512

 

44,712

 

 

 

 

 

 

 

Property and equipment, net

 

3,587

 

3,792

 

Restricted cash

 

303

 

190

 

Deferred financing costs, net

 

690

 

2,050

 

Other assets

 

348

 

270

 

Total assets

 

$

61,440

 

$

51,014

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity (Deficit)

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

7,521

 

$

4,565

 

Note payable, current portion

 

20,665

 

65

 

Capital lease obligations, current portion

 

1,103

 

1,027

 

Deferred revenue, current portion

 

952

 

952

 

Total current liabilities

 

30,241

 

6,609

 

 

 

 

 

 

 

Note payable, net of current portion

 

5,000

 

47,411

 

Capital lease obligations, net of current portion

 

1,189

 

2,024

 

Deferred revenue, net of current portion

 

635

 

1,349

 

Long-term interest payable and other liabilities

 

1,020

 

3,016

 

Mandatorily redeemable convertible preferred stock Series D 3,750 shares designated, 3,213 shares issued and outstanding in 2005

 

 

64,267

 

Total liabilities

 

38,085

 

124, 676

 

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

Convertible Preferred Stock, $0.001 par value, 16,250 shares authorized, 12,250 shares designated and 10,651 shares outstanding in 2005

 

 

32,746

 

Common stock, $.001 par value, 90,000 shares authorized 27,299 and 9,098 shares outstanding in 2006 and 2005

 

27

 

9

 

Additional paid-in-capital

 

198,163

 

36,404

 

Deferred compensation

 

 

(277

)

Accumulated deficit

 

(174,835

)

(142,544

)

Total stockholders’ equity (deficit)

 

23,355

 

(73,662

)

Total liabilities and stockholders’ equity (deficit)

 

$

61,440

 

$

51,014

 

 

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

3




OSIRIS THERAPEUTICS, INC.
Condensed Statements of Operations
(Unaudited)
Amounts in thousands, except per share data

 

 

 

Three Months Ended September 30,

 

 

 

2006

 

2005

 

Revenues:

 

 

 

 

 

Product Sales

 

$

2,539

 

$

284

 

Cost of goods sold

 

1,113

 

220

 

Gross profit

 

1,426

 

64

 

 

 

 

 

 

 

Revenue from collaborative research licenses and grants

 

302

 

1,001

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Research and development

 

9,242

 

3,464

 

General and administrative

 

5,300

 

554

 

Total operating expenses

 

14,542

 

4,018

 

 

 

 

 

 

 

Loss from operations

 

(12,814

)

(2,953

)

 

 

 

 

 

 

Interest expense, net

 

(2,751

)

(1,725

 

 

 

 

 

 

 

Net loss

 

$

(15,565

)

$

(4,678

)

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.75

)

$

(0.52

)

 

 

 

 

 

 

Weighted Average Common Shares (basic and diluted)

 

20,769

 

8,957

 

 

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

4




OSIRIS THERAPEUTICS, INC.
Condensed Statements of Operations
(Unaudited)
Amounts in thousands, except per share data

 

 

 

Nine Months Ended September  30,

 

 

 

2006

 

2005

 

Revenues:

 

 

 

 

 

Product Sales

 

$

5,333

 

$

284

 

Cost of goods sold

 

2,364

 

220

 

Gross profit

 

2,969

 

64

 

 

 

 

 

 

 

Revenue from collaborative research licenses and grants

 

895

 

2,725

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Research and development

 

24,532

 

9,713

 

General and administrative

 

7,647

 

1,793

 

Total operating expenses

 

32,179

 

11,506

 

 

 

 

 

 

 

Loss from operations

 

(28,315

)

(8,717

)

 

 

 

 

 

 

Interest expense, net

 

(3,976

)

(3,223

)

 

 

 

 

 

 

Net loss

 

$

(32,291

)

$

(11,940

)

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(2.47

)

$

(1.33

)

 

 

 

 

 

 

Weighted Average Common Shares (basic and diluted)

 

13,063

 

8,953

 

 

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

5




OSIRIS THERAPEUTICS, INC.
Statement of Stockholders’ Equity (Deficit )
For the nine months ended September 30, 2006
(Unaudited)
Amounts in thousands, except for share and per share data

 

 

 

Convertible

Preferred Stock

 

Common Stock

 

Additional

Paid-in

 

Deferred

 

Accumulated

 

Total

Stockholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Compensation

 

Deficit

 

Equity (Deficit)

 

Balance at January 1, 2006

 

10,650,544

 

$

32,746

 

9,097,506

 

$

9

 

$

36,404

 

$

(277

)

$

(142,544

)

$

(73,662

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of options to purchase common stock ($0.40 per share)

 

 

 

 

 

156,187

 

 

60

 

 

 

 

 

60

 

Exercise of warrants to purchase common stock ($0.40 per share)

 

 

 

 

 

875,000

 

1

 

349

 

 

 

 

 

350

 

Issuance of common stock for services rendered by directors ($11.00 per share)

 

 

 

 

 

22,807

 

 

198

 

 

 

 

 

198

 

Issuance of common stock for services rendered by consultant ($6.84 per share)

 

 

 

 

 

6,250

 

 

43

 

 

 

 

 

43

 

Reclassification due to adoption of new accounting standard

 

 

 

 

 

 

 

 

 

(277

)

277

 

 

 

 

Initial public offering of common stock, net of offering costs ($11.00 per share)

 

 

 

 

 

3,500,000

 

3

 

34,399

 

 

 

 

 

34,402

 

Conversion of convertible preferred stock into common stock

 

(10,650,544

)

(32,746

)

2,833,914

 

3

 

32,743

 

 

 

 

 

 

Conversion of mandatorily redeemable preferred stock into common stock

 

 

 

 

 

8,033,388

 

8

 

64,259

 

 

 

 

 

64,267

 

Conversion of convertible notes payable into common stock

 

 

 

 

 

2,774,076

 

3

 

25,320

 

 

 

 

 

25,323

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

4,665

 

 

 

 

 

4,665

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(32,291

)

(32,291

)

Balance at September 30, 2006

 

 

$

 

27,299,128

 

$

27

 

$

198,163

 

$

 

$

(174,835

)

$

23,355

 

 

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

6




 

OSIRIS THERAPEUTICS, INC.
Condensed Statements of Cash Flows
(Unaudited)
Amounts in thousands

 

 

 

Nine Months Ending September 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Cash flows from operations:

 

 

 

 

 

Net loss

 

$

(32,291

)

$

(11,940

)

Adjustments to reconcile net loss to net cash used in operations:

 

 

 

 

 

Depreciation and amortization

 

1,139

 

1,178

 

Non cash compensation expense

 

5,887

 

193

 

Non cash interest expense

 

3,961

 

2,464

 

Increase (decrease) in cash resulting from changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(39

)

(692

)

Inventory and other current assets

 

(1,579

)

(595

)

Other assets

 

(78

)

4

 

Accounts payable and accrued expenses

 

2,956

 

681

 

Deferred revenue

 

(714

)

(714

)

Long-term interest payable and other liabilities

 

(1,996

)

(96

)

Net cash used in operations:

 

(22,754

)

(9,517

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(933

)

(132

)

Proceeds from sale of short-term investments

 

26,586

 

 

Purchase of short-term investments

 

(35,805

)

(15,838

)

Net cash used in investing activities

 

(10,152

)

(15,970

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Principal payments on capital lease obligations and notes payable

 

(808

)

(664

)

Restricted cash

 

(113

)

17

 

Proceeds from notes payable

 

 

16,903

 

Proceeds from the issuance of common and preferred stock, net of offering costs

 

34,795

 

11,661

 

Payment of debt financing costs

 

 

(1,559

)

Net cash provided by financing activities

 

33,874

 

26,358

 

 

 

 

 

 

 

Net increase in cash

 

968

 

871

 

Cash at beginning of period

 

597

 

488

 

 

 

 

 

 

 

Cash at end of period

 

$

1,565

 

$

1,359

 

 

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

7




 

OSIRIS THERAPEUTICS, INC.
 NOTES TO CONDENSED FINANCIAL STATEMENTS
Amounts in thousands, except for share and per share data

1.             Basis of Presentation

The accompanying unaudited financial statements of Osiris Therapeutics, Inc. (the “Company”) have been prepared in accordance with generally accepted accounting principles in the United States and the rules and regulations of the Securities and Exchange Commission, (the “SEC”), for interim financial information.  Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Company’s Registration Statement on Form S-1, as amended (Registration No. 333-134037), which was declared effective by the SEC on August 3, 2006.  The financial information as of September 30, 2006 and 2005 and for the three and nine months then ended is unaudited, but in the opinion of management all adjustments, consisting only of normal recurring accruals, considered necessary for a fair statement of the results of these interim periods have been included.  The results of the Company’s operations for any interim period are not necessarily indicative of the results that may be expected for any other interim period or for a full fiscal year.

2.             Initial Public Offering, Non-Cash Charges and Reverse Stock Split

On August 9, 2006, the Company consummated its initial public offering, consisting of 3,500,000 shares of common stock at a public offering price of $11.00, resulting in net proceeds to the Company of approximately $34.4 million (after deducting payment of underwriters discounts and commissions, as well as offering expenses).

In connection with the initial public offering, the Company effected a 1-for-4 reverse stock split of the issued and outstanding common stock.  Information relating to common stock and common stock-equivalents set forth in this report (including the share numbers in the preceding paragraph) have been restated to reflect this split for all periods presented.  Upon consummation of the initial public offering, all shares of the Company’s Class I, Series 2003, Series B, Series C, Series E and the Mandatorily Redeemable Series D convertible preferred stock were converted into an aggregate of 10,867,302 shares of our common stock.  In addition, approximately $21.8 million of our convertible notes payable, together with accrued interest, were converted into an aggregate of 2,774,076 shares of our common stock.

Immediately following the initial public offering, we had 27,198,307 shares of common stock outstanding.

In the three months ended September 30, 2006, we incurred $7.0 million in non-recurring, non-cash charges relating to the completion of the initial public offering.  Included in General and Administrative expenses is a charge of $0.8 million for stock-based compensation related to the accelerated vesting of certain employee stock options pursuant to employment agreements.  We also recognized in General and Administrative expense a $3.5 million charge related to warrants that were priced upon the completion of the initial public offering. Interest expense for the three months ended September 30, 2006 includes $2.7 million in previously deferred financing costs and premiums that were expensed as a result of debt that was converted into common stock at the completion of the initial public offering.

3.             Significant Accounting Policies and Recent Accounting Pronouncements

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 revenue recognition, deferred tax assets, and stock-based compensation.

Revenue recognition

Our revenue recognition policies are in accordance with the SEC’s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by SEC Staff Accounting Bulletin No. 104, Revenue Recognition.

In July 2005, we launched Osteocel, our first commercial product. We recognize revenue on Osteocel sales when legal title to the product has passed to the customer, which is generally when the product is shipped from our Baltimore, MD facilities. We have agreements with our customers that specify the terms of sale, including price.

8




Cost of Goods Sold

Costs of goods sold consists primarily of the costs to obtain tissue, direct labor and other chemicals and supplies for Osteocel, which we launched in July 2005.   Beginning in 2006, we estimate the portion of our facilities and general and administrative expenses that are directly attributable to our manufacturing activities, and include these costs in cost of goods sold.

Loss per Common Share

Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted loss per common share adjusts basic loss per share for the potentially dilutive effects of shares issuable under our stock option plan, and the conversion of our preferred stock and convertible debt, using the treasury stock method. Common equivalent shares from the conversion of preferred stock and convertible debt and the exercise of stock options and warrants are excluded from the computation of diluted loss per share as their effect is antidilutive.

Stock-Based Compensation

On January 1, 2006, we adopted the provisions of Financial Accounting Standards Board Statement No. 123R, Share-Based Payment (Statement 123R). Statement 123R sets accounting requirements for “share-based” compensation to employees, and requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation.

In 1994, the Company adopted the Amended and Restated 1994 Stock Incentive Plan (the 1994 Plan) under which 875,000 shares of common stock have been reserved for issuance upon the exercise of options or other equity grants that we issue from time to time.  In 2006, we adopted the 2006 Omnibus Plan, under which we reserved 850,000 shares of common stock for issuance upon the exercise of stock options or other equity grants.  We stopped granting options under the 1994 Plan upon the completion of our initial public offering in August 2006.

A summary of the combined activity under both of our stock-based compensation plans as of September 30, 2006 and changes during the nine months then ended is presented below.

 

 

 

Number of
Shares

 

Weighted Average
Exercise Price at
Grant Date

 

Weighted Average
Remaining Term
(Years)

 

Aggregate
Intrinsic Value

 

Outstanding at December 31, 2005

 

566,480

 

$

0.40

 

 

 

 

 

Granted

 

313,000

 

4.01

 

 

 

 

 

Exercised

 

(156,187

)

0.40

 

 

 

 

 

Forfeited or expired

 

(5,563

)

0.40

 

 

 

 

 

Outstanding at September 30, 2006

 

717,730

 

$

1.97

 

8.92

 

$

5,121

 

Exercisable at September 30, 2006

 

404,869

 

$

0.40

 

7.91

 

$

3,889

 

 

The weighted average grant date fair value of options granted during the nine months ended September 30, 2006 was $7.11 per share. The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $4.5 million. We received a total of $60 in cash from the exercises of options during the nine months ended September 30, 2006.  At September 30, 2006, options for 786,511 shares of common stock remain available for future grants under our 2006 Omnibus Plan.

Share-based compensation included in the statements of operations for the three and nine months ended September 30, 2006 was approximately $4.5 million and $4.7 million, respectively.  As of September 30, 2006, there was approximately $1.6 million of total unrecognized share-based compensation cost related to options granted under our plans that will be recognized over a weighted-average period of approximately 3-years.

Pro Forma Information under SFAS 123 for Periods Prior to January 1, 2006

Through fiscal year 2005, the Company accounted for stock-based awards to employees using the intrinsic value method in accordance with APB 25 and related interpretations and provided the required pro forma disclosures of SFAS 123. Under APB 25 the compensation expense is calculated as the difference between the fair value of the common stock on the date such options were granted and their exercise price.

9




The following table summarizes the pro forma effect on the net loss and per share data if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation for the nine-month period ended September 30, 2005.

 

 

Nine Months
Ended
September 30, 2005

 

Net loss

 

$

(11,940

)

Add: Stock-based employee compensation expense included in net loss

 

51

 

Less: Stock-based employee compensation expense determined under SFAS 123

 

(7

)

 

 

 

 

Pro forma net loss

 

$

(11,896

)

 

 

 

 

Net loss per share:

 

 

 

Basic and diluted, net loss as reported

 

$

(1.33

)

 

 

 

 

Pro forma basic and diluted, net loss

 

$

(1.33

)

 

The weighted average fair value of options granted during the nine months ended September 30, 2005 was $2.95 per share.

Significant New Accounting Pronouncement

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SAFS No. 157, “Fair Value Measurements.”  SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute.  Accordingly, SFAS 157 does not require any new fair value measurements, but may change current practice for some entities.  SFAS 157 is effective for fiscal years beginning after December 15, 2006.  Our adoption of SFAS No. 157 is not expected to have a material effect on our financial position or results of operations.

In September, the Securities and Exchange Commission issued Staff Accounting Bulletin, or SAB, No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment.  SAB No. 108 requires registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material based on relevant quantitative and qualitative factors.  The guidance is effective for the first fiscal period ending after November 15, 2006.  We are currently evaluating the impact of adopting SAB No. 108 on our financial position, results of operations and cash flows.

On July 13, 2006, the FASB issued Interpretation, or FIN, No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in our financial statements. It also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, among other things. The provisions of FIN No. 48 are effective for us beginning January 1, 2007. We do not believe the adoption of this accounting pronouncement will have a material effect on our financial position, results of operations or cash flows.

5.             Long-Term Debt and Capital Lease Obligations

 

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

Bank Loan, payable in quarterly installments and bearing interest at LIBOR plus applicable margins, 6.64% - 7.14% in 2006

 

$

65

 

$

114

 

Line of Credit, 8%, to be repaid from future product sales

 

5,000

 

5,000

 

Term Note, 6% redeemable at the option of the holder after the IPO, due in 2008 (redeemed by the Company in October 2006)

 

20,600

 

20,600

 

Long-term debt that did not convert at the initial public offering

 

25,665

 

25,714

 

Term Note, 5% convertible into Common stock at $6.00/share

 

 

2,000

 

Term Notes, 6% convertible into common stock at initial public offering at specified prices

 

 

19,762

 

Long-term debt that converted upon the initial public offering

 

 

21,762

 

Total long-term debt

 

25,665

 

47,476

 

Less current portion

 

(20,665

)

(65

)

Long-term debt

 

$

5,000

 

$

47,411

 

 

 

 

 

 

 

Total capital lease obligations

 

2,292

 

3,051

 

Less current portion

 

(1,103

)

(1,027

)

Capital lease obligations, long-term

 

$

1,189

 

$

2,024

 

 

10




During June 1995, we borrowed $750 from a commercial bank in connection with the acquisition and renovation of our Baltimore, Maryland facilities.  This loan is partially guaranteed by an agency of the State of Maryland and matures in September 2007.  This loan bears interest at LIBOR plus 2.0% to 2.5% (7.13% to 7.63% at September 30, 2006).  Compensating balance arrangements with Wachovia Bank require us to maintain a cash balance of 105% of the non-guaranteed portion of this loan, which is shown as a component of restricted cash in the accompanying balance sheet.  At September 30, 2006, this compensating balance requirement was $22.

During 2005, we had issued convertible promissory notes outstanding to twenty-six shareholders for a total of $19.8 million.  These notes accrue interest at 6% per annum, and provide for redemption premiums starting at 9% of the principal amount and escalating up to 27% of the principal amount, depending upon the date of redemption or conversion to Common Stock.  All twenty-six convertible promissory notes, together with accrued interest were subsequently converted into 2,376,223 shares of our common stock upon the completion of our initial public offering on August 9, 2006.

In December 2004, we issued a convertible promissory note to a foreign investor for $2.0 million.  This note bore interest at 5% and the principal and accrued interest was converted into 397,853 shares of our common stock upon the completion of our initial public offering on August 9, 2006.

In November 2005, we issued a $20.6 million promissory note to a foreign investor.  This note bears interest at 6% and has redemption premiums that start at 9% and increase over time up to 27%.  Interest payments are due in November 2006, 2007 and upon maturity in November 2008.  This note was convertible into our common stock only if the initial public offering took place after December 2006.  The note also contains demand features whereby the holder can request redemption and early repayment at any time after the completion of an initial public offering, and therefore this note is classified as a current liability in the condensed balance sheet at September 30, 2006.

In October 2006, we issued $20.0 million in convertible promissory notes in a private placement to Swiss investors and used the proceeds from these notes, plus $3.6 million in cash to redeem the $20.6 million promissory note.  See the Subsequent Events footnote for a more complete description of these transactions.

6.             Preferred Stock Conversion

All our convertible preferred stock was converted into common stock upon the completion of our initial public offering in August 2006, as follows:

 

 

September 30,

 

December 31,

 

No. Shares of
Common Stock
Issued Upon
Conversion at IPO
(Aggregate
Liquidation
Preference /
Conversion Price

 

 

 

2006

 

2005

 

Per Share

 

Convertible preferred stock, Class I, Series 2003, $0.001 par value, 2,000,000 shares designated, issued and outstanding in 2005

 

$

 

$

10,000

 

500,000

 

Convertible preferred stock, Series B, $0.001 par value, 750,000 shares designated, 545,454 shares issued and outstanding in 2005

 

 

3,000

 

136,364

 

Convertible preferred stock, Series C, $0.001 par value, 3,500,000 shares designated, 548,090 shares issued and outstanding in 2005

 

 

2,243

 

308,300

 

Convertible preferred stock, Series E, $0.001 par value, 8,000,000 shares designated, 7,557,000 shares issued and outstanding in 2005

 

 

17,503

 

1,889,250

 

 

 

$

 

$

32,746

 

2,833,914

 

 

We issued 2,000,000 shares of our Class I, Series 2003 convertible preferred stock to a collaborative partner as part of an agreement related to product development, clinical trials and FDA approval.  These shares were converted into 500,000 shares of our common stock at the conversion price of $20.00 per share.

We issued 545,454 shares of our Series B convertible preferred stock in 2003, as part of a collaborative agreement.  These shares were converted into 136,364 shares of our common stock at the conversion price of $22.00 per share.

11




We issued 548,090 shares of our Series C convertible preferred stock in 2004 at the price of $4.50 per share.  These shares were converted into 308,300 shares of our common stock at the conversion price of $8.00 per share.

We issued 7,557,000 shares of our Series E convertible preferred stock in 2005 at a price of $2.50 per share.  These shares were converted into 1,889,250 shares of our common stock at the conversion price of $10.00 per share.

Also in 2005, we issued 3,213,335 shares of Series D Mandatorily Redeemable Convertible Preferred Stock at a price of $2.00 per share. These shares were converted into 8,033,388 shares of our common stock at the conversion price of $0.80 per share.

These Series D shares included a mandatory redemption feature whereby if the Company did not complete an initial public offering prior to June 1, 2007 and the shares were not previously converted into common stock, the Company must then redeem the shares at a price of $20.00 per share. The Series D Mandatorily Redeemable Convertible Preferred Stock is recorded as a liability in the balance sheet at December 31, 2005, in accordance with SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” In addition to the initial net proceeds of $6.0 million from the Series D offering, a redemption premium of $58.3 million was recorded as a liability.

7.             Warrants

At September 30, 2006, the Company had warrants to purchase its common stock outstanding as shown in the following table.

 

 

 

Common Stock

 

 

 

# of
Shares

 

Weighted Average
Price Per Share

 

Warrants outstanding, January 1, 2006

 

2,125,000

 

$

0.40

 

Warrants granted

 

1,000,000

 

11.00

 

Warrants exercised

 

(875,000

)

0.40

 

Warrants cancelled

 

(1,250,000

)

0.40

 

Warrants outstanding, September 30, 2006

 

1,000,000

 

$

11.00

 

 

In connection with a 2004 financing arrangement, we issued warrants to purchase 1,250,000 shares of our common stock at $0.40 per share.  In the first half of 2006, these warrants were cancelled.  In May 2006, we issued warrants to Peter Friedli, the chairman of our board of directors, to purchase 1,000,000 shares of our common stock at the price our stock was offered to the public in the initial public offering.  These warrants have a five-year life and entitle Mr. Friedli to purchase up to 1,000,000 shares of our common stock for $11.00 per share at any time prior to expiration.

In August 2006, when the price of the warrant was determined, we computed its value using the Black-Scholes option pricing method, using a risk free interest rate of 4.80% (5-year US Treasury interest rate), the expected life of 2.5-years and a stock volatility factor of 44.66%.  Since the Company just recently completed its initial public offering and previously its stock did not trade, we determined the volatility by selecting a comparable public company in the biotech industry and tracking its stock prices over the past 2.5-years.  The value of these warrants was determined to be $3.5 million which as been recorded in the accompanying income statement as General and Administrative expenses.

The 875,000 warrants that were exercisable at $0.40 per share as of January 1, 2006 were all exercised concurrent with the closing of our initial public offering in August 2006.

8.             Subsequent Events

In October 2006, subsequent to the end of the third fiscal quarter, we issued $20.0 million in convertible promissory notes in a private placement to several Swiss investors.  The notes bear interest at a rate of 10%, with semi-annual payments of accrued interest becoming due and payable on April 30 and October 30 of each calendar year, until maturity on April 30, 2009.  The notes are convertible at the option of the respective holders at any time after February 9, 2007, into shares of common stock at the conversion price of $18.00 per share.   The notes automatically convert into common stock at the same conversion price, if at any time after February 9, 2007, the closing price of the Company’s common stock for ten consecutive trading days equals $25.00 per share or greater.  The notes provide for redemption at any time at the option of the Company, with 30-day written notice.

The net proceeds from these notes have been applied to the repayment in full of the $20.6 million convertible promissory note issued in November 2005 to a foreign investor.  Repayment of this note in October 2006, allowed the Company to avoid an increase in the premium obligation of up to 18% or $3.7 million, which would have been payable had the prior note been held to maturity.  After accounting for costs to refinance and interest rate differences, total net savings to the Company over the prior note’s full term are estimated to be $3.2 million.

 

12




 

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction and Overview.

Forward-looking Statements

This report contains forward-looking statements. Forward-looking statements provide our current expectations or forecasts of future events. Forward-looking statements include statements about our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts. Words or phrases such as “anticipate,” “believe,” “continue,” “ongoing,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or similar words or phrases, or the negatives of those words or phrases, may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Examples of forward-looking statements include, but are not limited to, statements regarding the following: our product development efforts; our clinical trials and anticipated regulatory 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 strategy for Mesenchymal stem cells or MSCs and biologic drug candidates; our cash needs; patents and proprietary rights; ability of our potential products to treat disease; our plans for sales and marketing; our plans regarding our facilities; types of regulatory frameworks we expect will be applicable to our potential products; and results of our scientific research. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in forward-looking statements for many reasons, including the factors described in the section entitled “Risk Factors” in our Registration Statement on Form S-1, File No: 333-134037, as filed with the United States Securities and Exchange Commission and declared effective on August 3, 2006. Accordingly, you should not unduly rely on these forward-looking statements. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this report or to reflect the occurrence of unanticipated events.

Overview

We are a leading stem cell therapeutic company focused on developing and marketing products to treat medical conditions in the inflammatory, orthopedic and cardiovascular areas. Our marketed product, Osteocel, and our biologic drug candidates utilize mesenchymal stem cells, or MSCs. In July 2005, we launched Osteocel for regenerating bone in orthopedic indications. We currently have five clinical trials ongoing. We are currently enrolling patients in a Phase III clinical trial for Prochymal, our lead biologic drug candidate, for the treatment of steroid refractory Graft versus Host Disease, or GvHD. Prochymal is also in Phase II clinical trials for acute GvHD and Crohn’s Disease. In addition, we have two other clinical stage biologic drug candidates, Chondrogen for regenerating cartilage in the knee, and Provacel for repairing heart tissue following a heart attack. We have developed stem cell capabilities in research and development, manufacturing, marketing and distribution. We manufacture Osteocel and clinical batches of our biologic drug candidates. We distribute Osteocel in orthopedic indications and jointly distribute Osteocel with Blackstone Medical, Inc. for spinal procedures.

We have incurred annual operating losses since inception and expect to incur substantial operating losses in the future in connection with the development of our core products. As of September 30, 2006, we had an accumulated deficit of $174.8 million.

Financial Operations Overview

Revenue

Osteocel is our only commercial product. Sales of Osteocel generated revenue of approximately $5.3 million for the nine months ended September 30, 2006. In prior years, we have entered into strategic agreements with other companies for the development and commercialization of select stem cell biologic drug candidates for specific indications and geographic markets. In 2003, we entered into an agreement with a major pharmaceutical company relating to the development of our cardiac biologic drug candidate, and we received a $5.0 million fee for licensing the use of our technology. This fee is being recognized as revenue over a 63-month period, $0.7 million of which was recognized in the first nine months of 2006 and 2005. Also in 2003, we entered into an agreement with a foreign pharmaceutical company granting it exclusive rights to Prochymal for the treatment of GvHD in Japan. We recognized $0.5 million of revenue during the nine months ended September 2005 related to this agreement. We do not expect to enter into collaborations in the future.

Historically, we have also recognized revenue from governmental grants for research and in the first nine months of 2005, we recorded $1.4 million in grant revenues from three separate grants. Revenue from research grants is recognized as the related research expenditures are incurred. During 2006, we did not have any active government grants and, we do not expect to solicit governmental grants in the future.

Other than Osteocel, we have no commercial products for sale. A substantial portion of our revenue in the future will be dependent on the approval and sale of our biologic drug candidates. Our revenue may vary substantially from quarter to quarter and from year to year. We believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicative of our future performance.

13




Cost of Goods Sold

Our cost of goods sold relate to direct costs of producing Osteocel, which we launched in July 2005. Cost of goods sold consist primarily of the costs of obtaining tissue and other chemicals and supplies, direct labor and allocated costs of our facilities and overhead.

Research and Development Costs

Our research and development costs consist of expenses incurred in identifying, developing and testing biologic drug candidates. 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. As a result, we cannot state precisely the total costs incurred for each of our clinical and preclinical projects on a project-by-project basis. From inception through September 30, 2006, we incurred aggregate research and development costs of approximately $168 million.

We expect our research and development expenses to increase substantially in the future, as we expand our clinical trial activity, as our biologic drug candidates 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 the uncertainties discussed above, 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. Following the initial public offering, we anticipate increases in our general and administrative expense for legal and accounting compliance costs, investor relations and other activities associated with operating as a publicly traded company. These increases will also likely include the hiring of additional operational, financial, accounting, facilities engineering and information systems personnel.

Interest Expense, Net

Interest income consists of interest earned on our cash and short-term investments. Interest expense consists of interest incurred on capital leases and other debt financings. We pay interest on our bank loan and capital leases and accrue non-cash interest on some of our convertible long-term debt.

Income Taxes

We have not recognized any 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 carryforwards. In the event that we become profitable within the next several years, we have net deferred tax assets of approximately $60 million that may be utilized prior to us having to recognize any income tax expense or make payments to the taxing authorities. Utilization of our net operating loss carryforwards in any one year may be limited however, and we could be subject to the alternative minimum tax.

14




Critical Accounting Policies

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of our financial statements as well as the reported revenues and expenses during the reported periods.  We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in the notes to our audited financial statements for the year ended December 31, 2005 included in the Registration Statement on Form S-1, as amended (Registration No. 333-134037), which was declared effective by the SEC on August 3, 2006.

Results Of Operations

Comparison of Quarters ended September 30, 2006 and 2005

Revenue

Total revenues increased 121% to $2.8 million for the quarter ended September 30, 2006, compared to $1.3 million in the third quarter of 2005. Our revenues in 2006 resulted primarily from $2.5 million generated from the sale of Osteocel and the recognition of $0.3 million in licensing fees and royalties. In the quarter ended September 30, 2005, we recognized $0.3 million in Osteocel sales and $1.0 million in license fees and grants.

Cost of Goods Sold

Cost of goods sold were $1.1 million for the quarter ended September 30, 2006 compared to $0.2 million in the third quarter of 2005. The cost of goods sold associated with sales of Osteocel was comprised of payments to tissue banks, direct labor costs and the costs of processing, testing and preserving Osteocel, as well as allocations of our facilities and overhead costs.  The gross margin on Osteocel sales in the third quarter of 2006 was 56%.  The gross margin for the third quarter of 2005 was 23%, reflecting the start-up of commercial activities in July 2005.

Research and Development Expenses

Research and development expenses were approximately $9.2 million for the quarter ended September 30, 2006 compared to $3.5 million in the prior year. The increase in research and development expenses in 2006 reflects the increased number of clinical trials in process verses the prior year. In 2006, we incurred costs associated with the enrollment of a Phase II trial for Prochymal as an add-on therapy to steroids for the first-line treatment of acute GvHD, a Phase II trial for Prochymal for treatment of steroid refractory GvHD, a Phase II trial for Prochymal for treatment of Crohn’s Disease, a Phase I/II clinical trial for Chondrogen, and a Phase I clinical trial for Provacel.

General and Administrative Expenses

General and administrative expenses were $5.3 million for the quarter ended September 30, 2006 compared to $0.6 million in the third quarter of 2006.  The 2006 expenses include $4.4 million in non-cash stock-based compensation charges related to certain options that vested upon the completion of the initial public offering, pursuant to employment agreements and the value of a warrant that became determinable upon the completion of the initial public offering.  General and administrative expenses, exclusive of these non-cash charged during the third quarter of 2006 were $0.9 million, compared to $0.6 million in the prior year. The increase in general and administrative expenses was attributable to additional personnel and related costs to support the company’s growth and greater costs incurred in connection with being a public company.

Interest Expense, Net

Interest expense, net was $2.8 million for the quarter ended September 30, 2006, and includes the recognition of previously deferred financing costs and premiums associated the debt that was converted into common stock at the completion of the initial public offering.  Excluding items related to the initial public offering, net interest expense for the third quarter of 2006 was $0.1 million, compared to $1.7 million in the prior year.  The reduction is the result of higher interest income from the proceeds of the initial public offering that were invested in investment-grade short-term securities and the conversion of $21.8 million of interest bearing debt to common stock in August 2006.

Comparison of Nine Months ended September 30, 2006 and 2005

Revenue

Total revenues increased 107% to $6.2 million for the nine months ended September 30, 2006, compared to $3.0 million in the corresponding period in 2005. Our revenues in 2006 resulted primarily from $5.3 million generated from the sale of Osteocel and the recognition of $0.9 million in licensing fees and royalties. In the nine months ended September 30, 2005, we recognized $0.3 million from the sale of Osteocel and $2.7 million in license fees and grants.

15




Cost of Goods Sold

Cost of goods sold were $2.4 million for the nine months ended September 30, 2006 compared to $0.2 in the prior year. The cost of goods sold associated with sales of Osteocel was comprised of payments to tissue banks, direct labor costs and the costs of processing, testing and preserving Osteocel, plus allocated costs of our facilities and overhead. The gross margin on Osteocel sales for the nine months ended September 30, 2006 was 56%, compared with 23% for 2005.  The 2005 gross margin reflects the start-up of commercial operations.

Research and Development Expenses

Research and development expenses were approximately $24.5 million for the nine months ended September 30, 2006 compared to $9.7 million in the prior year. The increase in research and development expenses in 2006 reflects the increased number of clinical trials in process verses the prior year. In 2006, we incurred costs associated with the enrollment of a Phase II trial for Prochymal as an add-on therapy to steroids for the first-line treatment of acute GvHD, a Phase II trial for Prochymal for treatment of steroid refractory GvHD, a Phase II trial for Prochymal for treatment of Crohn’s Disease, a Phase I/II clinical trial for Chondrogen, and a Phase I clinical trial for Provacel.

General and Administrative Expenses

General and administrative expenses were $7.6 million for the nine months ended September 30, 2006 compared to $1.8 million in the prior year.  The increase in 2006 includes $4.4 million of non-cash charges associated with the completion of our initial public offering.  Exclusive of these charges, general and administrative expenses in 2006 were $3.2 million and the increase over the prior year was attributable to additional personnel and related costs to support the company’s growth and costs incurred in connection with being a public company.

Interest Expense, Net

Interest expense, net was $4.0 million for the nine months ended September 30, 2006 compared to $3.2 million in the prior year. The 2006 costs include $2.7 million of previously deferred debt financing costs and premiums associated with debt that was converted into common stock upon the completion of our initial public offering.  Exclusive of these charges, net interest expense during 2006 was $1.3 million, a decrease of $1.9 million compared to 2005.  This decrease is the result of higher interest income related to the investment of the proceeds of the initial public offering and the $21.8 million decrease in debt, which was converted into common stock upon the completion of the initial public offering in early August 2006.

Liquidity and Capital Resources

Liquidity

At September 30, 2006, we had $1.6 million in cash and $52.0 million in short-term investments.  In addition to the sources described above, at September 30, 2006, we had drawn only $5.0 million of the $50.0 million line of credit available for the development of Provacel under a loan agreement with a pharmaceutical company. In connection with this line of credit, we have granted the pharmaceutical company a security interest in the intellectual property, equipment and books and records involved in the development, manufacture and distribution of Provacel. The pharmaceutical company is also obligated to make additional investments in our Company and pay licensing fees up to $45.0 million to us upon completion of certain milestones.

In addition to the $5.0 million balance on the line of credit, at September 30, 2006 our debt included approximately $20.6 million of a convertible promissory note due in 2008. Since September 30, 2006, we issued $20.0 million of 10% convertible promissory notes that mature in 2009.  These notes are convertible into common stock any time after February 9, 2007, at the conversion price of $18 per share.  The notes are automatically converted into common stock at the same conversion price if, after February 9, 2007, our common stock closes at $25 per share or greater for ten consecutive trading dates.  We used the proceeds of these notes, plus $3.6 million in cash to redeem the $20.6 million 6% convertible promissory note.  The prior note accrued interest at 6% together with premium payments of 9% initially and increasing to 27% if the note was held to maturity.  Repayment of the prior note allowed the Company to avoid an increase in the premium obligation of up to 18%, or $3.7 million, which would have been payable had the prior note been held to maturity.  After accounting for costs to refinance and interest rate differences, total net savings to the Company over the prior note’s full term are expected to be approximately $3.2 million.

Cash Flows

Net cash used in operating activities was $22.8 million for the nine months ended September 30, 2006 primarily reflecting our net loss of $32.3 million, partially offset by $0.5 million in favorable working capital, $4.0 million in non-cash interest and $5.9 in stock-based compensation expense and $1.1 million in depreciation and amortization. Other long-term liabilities decreased by $2.0 million, reflecting the reclassification of the accrued interest and principal on the $20.6 million convertible note payable that was redeemed in October 2006. Net cash used for operating activities was $9.5 million for the nine months ended September 30, 2005. Net cash used in operating activities for 2005 primarily reflects our net loss of $11.9 million, partially offset by $2.5 million in non-cash interest expense.

16




Net cash used in investing activities was $10.2 million for the nine months ended September 30, 2006.  Net cash used in investing activity for the nine months ended September 30, 2005 was $16.0 million. Net cash used in investing activities in 2006 includes cash flows from the purchase of $35.8 million of short-term investment, partially offset by the sale of $26.6 million of short-term investments.  In 2005, we purchased $15.9 million of short-term investments during the first nine-months of the year.

Net cash provided by financing activities was $33.9 million for the nine months ended September 30, 2006. Net cash provided by financing activities was $26.4 million for the nine months ended September 30, 2005 and consisted principally of $16.9 million in net proceeds from the issuance of convertible notes and $11.6 million in net proceeds from the issuance of common and preferred stock.  The cash provided by financing activities in the first nine months of 2006 was primarily from the proceeds of our initial public offering in August 2006.

Capital Resources.

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

·                    the level of cash flows from Osteocel sales;

·                    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 III trial for Prochymal;

·                    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 building and operating our manufacturing facilities, both in the near term to support Osteocel sales and our clinical activities and also in anticipation of expanding our commercialization activities;

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

·                    the costs of repaying our debt; and

·                    the costs of enlarging our work force consistent with expanding our business and operations and status as a public company, and as necessary to enhance and train our sales network in anticipation of the approval of our biologic drug candidates for commercial sale.

As a result of these factors, we may need or choose to seek additional funding prior to our becoming cash flow positive on an operational basis. We would likely seek such funding through public or private financings or some combination of them. Although not our current focus, we might also seek funding through collaborative arrangements if determined to be necessary or appropriate. Additional funding may not be available to us on acceptable terms, or at all. If we obtain capital through collaborative arrangements, these arrangements could require us to relinquish rights to our technologies or biologic drug candidates. If we raise capital through the sale of equity, or securities convertible into equity, dilution to our then existing stockholders would result. If we raise additional capital through the incurrence of debt, we would likely become subject to covenants restricting our business activities, and holders of debt  instruments would have rights and privileges senior to those of our equity investors. In addition, servicing the interest and repayment obligations under these borrowings would divert funds that would otherwise be available to support research and development, clinical or commercialization activities.

If we are unable to obtain adequate financing on a timely basis, we may be required to delay, reduce the scope of or eliminate one or more of our programs, any of which could have a material adverse effect on our business, financial condition and results of operations.

We expect that our available cash and interest income, including that raised in the initial public offering of our common stock, will be sufficient to finance currently planned activities through early 2008, although no assurance can be given that changes will not occur that would consume available capital resources before such time and we may need or want to raise additional financing within this period of time. These estimates are based on certain assumptions, which could be negatively impacted by the factors discussed above and under “Risk Factors” included in the Registration Statement on Form S-1, as amended (Registration No. 333-134037), which was declared effective by the SEC on August 3, 2006.

Off-Balance Sheet Arrangements.

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

Item 3.  Quantitative and Qualitative Disclosures About Market 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 fair market value of our portfolio.  Therefore, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio.

17




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-collect ability and establishment of appropriate allowances in connection with our internal controls and policies.

We do not enter into hedging or derivative instrument arrangements.

Item 4.   Controls and Procedures

Evaluation of Disclosure Controls and Procedures. An evaluation of the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as of the end of the period covered by this quarterly report on Form 10-Q was made under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (a) are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934 is timely recorded, processed, summarized and reported and (b) include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting. There have not been any changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

18




 

PART II — OTHER INFORMATION

Item 1.   Legal Proceedings

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

Item 1A.   Risk Factors

There have not been any material changes from the risk factors previously disclosed in “Risk Factors” of our Registration Statement on Form S-1, as amended (Registration No. 333-134037), which was declared effective by the SEC on August 3, 2006.

Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds

None

        Initial Public Offering and Use of Proceeds from Sales of Registered Securities

On August 9, 2006, we sold 3,500,000 shares of our common stock in our initial public offering at the price to the public of $11.00 per share.  The offer and sale of all of the shares in the offering were registered under the Securities Act of 1933, as amended, pursuant to a registration statement on Form S-1 (File No. 333-13407), which was declared effective by the Securities and Exchange Commission on August 3, 2006. The underwriters of the offering were Jefferies & Company, Inc., Lazard Capital Markets, LLC and Leerink Swann & Co., Inc.  There were no selling stockholders in the offering.

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

None of the underwriting discounts and commissions or offering expenses were incurred or paid to directors or officers of ours or their associates, to persons owning 10 percent or more of our commons stock or to any affiliates of ours.

After deducting the underwriting discounts and commissions and these other estimated offering expenses, our net proceeds from the offering were approximately $34.4 million.  We have deposited the net proceeds in two highly rated financial institutions in the United States.

There has been no material change in our planned use of proceeds from our initial public offering as described in our final prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b).

Item 3.   Defaults Upon Senior Securities

None

Item 4.   Submission of Matters to a Vote of Security Holders

None

Item 5.   Other Information

None

19




Item 6.   Exhibits

 

Exhibit
Number

 

Description of Exhibit

 

 

 

31.1

 

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) and 15D-14(a) under the Securities Exchange Act of 1934, as amended (Section 302 of the Sarbanes-Oxley Act of 2002).

 

 

 

31.2

 

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and 15D-14(a) under the Securities Exchange Act of 1934, as amended (Section 302 of the Sarbanes-Oxley Act of 2002).

 

 

 

32

 

Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 


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

20




SIGNATURE

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

 

 

Osiris Therapeutics, Inc.

 

 

 

 

 

 

Date: November 13, 2006

 

/s/ Cary J. Claiborne

 

 

Cary J. Claiborne

 

 

Chief Financial Officer

 

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