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OSIR > SEC Filings for OSIR > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for OSIRIS THERAPEUTICS, INC.


12-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

CAUTIONARY STATEMENTS ABOUT FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q 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 Quarterly 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 in our Annual Report on Form 10-K under Part I - 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; the success of our product candidates in development; implementation of our corporate strategy; our financial performance; our product research and development activities and projected expenditures, including our anticipated timeline and commercialization strategy for marketed biosurgery products (including Grafix®, Ovation®, Ovation OSTM, and Cartiform®); our cash needs; patents, trademarks and other proprietary rights; the safety and ability of our products perform as intended or expected; our ability to supply a sufficient amount of our marketed products or product candidates and, if or insofar as approved or otherwise commercially available, 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 establishing and maintain reimbursement for our commercially available products; types of regulatory frameworks we expect will be 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 Quarterly 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.

You should read the following management's discussion and analysis of our financial condition and results of operations in conjunction with our audited financial statements and related notes thereto and other disclosures included as part of our Annual Report on Form 10-K for the year ended December 31, 2012, and our unaudited condensed financial statements for the three and nine month periods ended September 30, 2013 and other disclosures included in this Quarterly Report on Form 10-Q, and our Current Reports on Form 8-K during these periods and since then to date. Our condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and are presented in U.S. dollars.

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report. Some of the important factors that could cause our actual results to differ materially from the forward-looking statements we make in this report are set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 under Part I - Item 1A "Risk Factors." Risks and uncertainties related to our recent transaction with Mesoblast are included in this Quarterly Report on Form 10-Q under Part II-Item 1A "Risk Factors." There may be other factors that may cause our actual results to differ materially from the forward-looking statements.

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

Introduction and Overview

The following is a discussion and analysis of our financial condition and results of operations for the three and nine month periods ended September 30, 2013 and 2012. You should read this discussion together with the accompanying unaudited condensed financial statements and notes and with our Annual Report on Form 10-K for the year ended December 31, 2012. Historical results and any discussion of prospective results may not indicate our future performance. See "Cautionary Statements About Forward-Looking Information."

We are a leading stem cell company headquartered in Columbia, Maryland and focused on developing and marketing products in the orthopedic, sports medicine and wound care markets. We are a fully integrated company, having developed capabilities in research, development, manufacturing, marketing and distribution. We have developed an extensive intellectual property portfolio to protect our technology and commercial interests.

Since 2010, we have had two business segments, Biosurgery and Therapeutics.

Our Biosurgery business, 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 has historically focused on developing biologic stem cell drug candidates from a readily available and non-controversial source-adult bone marrow.


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Our Biosurgery business has continued to grow since its inception, and we have increased our organizational focus on the development and commercialization of products in this segment.

Consistent with this focus, on October 10, 2013, we entered into a Purchase Agreement with Mesoblast Limited ("Mesoblast") for our culture expanded mesenchymal stem cell business, including Prochymal and other related assets. Our continuing operations now represent the portion of our business previously referred to as our Biosurgery segment.

In our Biosurgery business, we currently manufacture, market and distribute Grafix, Ovation, Cartiform, and OvationOS for tissue repair. 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 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. Since the third quarter of 2010, we have launched commercial distribution of several Biosurgery products, including Grafix, Ovation, Cartiform, and OvationOS, each 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, which we have since sold to Nuvasive, Inc. Disease targets for Biosurgery products commercialized or in development include diabetic foot ulcers, venous stasis ulcers, dermal burns, and orthopedic and cartilage repair.

Grafix is a three-dimensional tissue matrix for use as a wound covering for application directly to acute and chronic wounds, including diabetic foot ulcers, venous leg ulcers, and burns. Flexible and conforming to complex anatomies, this tissue matrix retains a rich source of extracellular matrix, viable endogenous cells including MSCs, as well as growth factors.

Ovation is a novel cellular repair matrix. Easily applied to the site of injury, Ovation provides three essential components-collagen matrix, viable endogenous MSCs and growth factors such as BMPs and VEGF-to support tissue regeneration.

OvationOS, a viable bone matrix, is our newest product to be used for bone repair and regeneration. It is a cancellous bony matrix containing viable endogenous MSCs and osteoprogenitor cells. It contains key components for bone regeneration, including structural biologic matrix, reservoir of growth factors and endogenous MSCs. OvationOS is a functionally complete alternative to autograft, the "gold standard" in bone regeneration. These components naturally have the following capacities:

†          Osteoinduction (stimulating recruitment of neighboring host cells)

†          Osteoconduction (serving as a scaffold to support bone growth)

†          Osteogenesis (bone-forming).

†          Angiogenesis (blood vessel-forming, important for supply of nutrition
and factors to the neotissue)

Cartiform is viable cartilage mesh designed for use in cartilage repair, such as marrow stimulation procedures. Cartiform uses a type II collagen architecture and functioning chondrocytes to preserve the natural properties of hyaline cartilage and recruit the patient's MSCs for improved chondrogenesis.

Grafix, OvationOS, and Cartiform 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.

In October 2013, we announced an agreement with FDA on the regulatory status of our marketed Biosurgery products and confirmed the HCT/Ps pathway for Grafix indicated as a wound cover for the treatment of acute and chronic wounds. At that time we announced our intentions to file a Biologic License Agreement ("BLA") for Grafix to enable us to expand the label claims. Additionally, we will continue transitioning our Ovation product line over to our newly launched OvationOS formulation and have agreed to complete this transition no later than the second half of 2014.

We market and distribute Grafix and Ovation through a network of agents and distributors, as well as directly to hospitals and clinics. We began to distribute Cartiform in and OvationOS during 2013, and currently market them directly to hospitals.

A significant market for Grafix is chronic wounds, which are primarily treated in the outpatient setting. To obtain full reimbursement for use of Grafix in the outpatient setting, we initiated a prospective randomized clinical trial comparing the standard of care to Grafix during the second fiscal quarter of 2012.

This trial was a multicenter, adaptive design, randomized study to evaluate the efficacy and safety of Grafix for the treatment of chronic diabetic foot ulcers. Patients in the study are randomized in a 1:1 ratio to receive either Grafix or conventional standard of care for a chronic diabetic foot ulcer that is between 1 cm2 and 15 cm2. 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, proportion of patients with at least


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50% reduction in wound size by Day 28 and number of applications of Grafix versus control. This trial was conducted at 20 wound care clinics across the U.S.

On August 13, 2013, we reported that this study had met the pre-specified stopping rules for overwhelming efficacy as determined by the data monitoring committee during a planned interim analysis, as well as on all top-line secondary endpoints, demonstrating faster wound closure and a reduction in the number of treatments needed to achieve wound closure. As a result, the blinded phase of the trial was discontinued immediately and all patients randomized to the control arm were offered treatment with Grafix.

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.

In October 2013, we announced our intention to initiate a new clinical trial for Grafix for the treatment of venus leg ulcers. We have commenced a pilot study to enable us to design the clinical trial which should be formally initiated during fiscal 2014.

Therapeutics Segment. Our Therapeutics segment historically 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), was 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 subsequently also received approval from Medsafe in New Zealand for the same indication.

In October 2013, we entered into an agreement with a wholly-owned subsidiary of Mesoblast Limited, (ASX: MSB; USOTC: MBLTY) for the sale of our culture-expanded mesenchymal stem cell ("ceMSC") business, including Prochymal, in a transactions worth up to $100 million in initial consideration and milestone payments. Additionally, we have the opportunity to receive royalty payments ranging from the low single digit to 10% on future sales of Prochymal and other products utilizing the ceMSC technology.

We will receive $50 million in consideration for closing and delivery of the the ceMSC assets. Of this amount, $20 million in cash was paid upon closing and another $15 million in cash is payable to us upon the six month anniversary of closing. We will receive the remaining $15 million in either ordinary shares of Mesoblast or cash, at Mesoblast's sole discretion upon the delivery of the ceMSC assets. The $50 million in initial consideration will be recorded in the fourth quarter of 2013. Any shares of Mesoblast stock we receive will bear restrictive legends and not be tradable for 12-months, in accordance with Australian securities laws. Mesoblast has granted us limited downside protection in the event the value of the shares declines between the date the shares are granted and the date when the restrictions expire.

We are also eligible to receive up to an additional $50 million in payments upon Mesoblast achieving certain clinical and regulatory milestones.

Financial Operations Overview

Revenue

Biosurgery Segment. Beginning in fiscal 2010, we started to account for our Biosurgery business as a separate segment. We manufacture our Biosurgery products in our Columbia, Maryland facility and distribute these products through a network of independent distributors as well as through employee sales personnel. We presently manufacture and distribute Grafix and Ovation for the treatment of chronic wounds and burns, Cartiform for cartilage repair, and OvationOS for bone repair and regeneration. Each of these products is cryopreserved and stored in low temperature freezers at -80 degrees Celsius. Customers have the product shipped to them on dry ice. We distribute Biosurgery products to both end user customers and distributors who redistribute the products to end users. Legal title passes to stocking distributors when the product leaves our shipping dock. Some end user customers take legal title to the products only when the product is used in a medical procedure, thus we maintain consignment inventory at end user hospitals or clinics. Due to the nature of the products, we usually do not allow sales returns.

Since 2010, we have developed and launched multiple Biosurgery products for commercial distribution, and have additional product candidates under development. We have continued to increase our distribution volumes of Grafix and Ovation since their respective commercial launches, both through in-house personnel as well as through our expanding distributor network. We expect the same for Cartiform and OvationOS. The increase in revenue and gross profit since commercial launch is primarily 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. As discussed above, on October 10, 2013, we entered into a Purchase Agreement with Mesoblast for our culture expanded mesenchymal stem cell business, including Prochymal and other related assets. Accordingly, we have presented the results of the group's operations as a discontinued operation for all periods. Historically, our Therapeutics segment generated revenues primarily from collaborative agreements, royalties, and cost reimbursement under our adult expanded access program.


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Research and Development Costs

To date, our research and development costs have consisted of expenses incurred in identifying, developing and testing 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, costs of biologic tissue based products, and quality control supplies.

From inception in December 1992 through September 30, 2013, we incurred aggregate research and development costs of approximately $432 million.

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

                                         Three Months Ended       Nine Months Ended
                                           September 30,            September 30,
                                          2013         2012        2013        2012

Continuing operations:
Biosurgery segment                     $      885    $  1,185   $    2,503   $  3,604

Discontinued operations:
Therapeutics segment                        1,326       1,798        6,017      7,414

Total research and development costs   $    2,211    $  2,983   $    8,520   $ 11,018

We expect our research and development expenses to continue to be substantial in the future, as we continue our clinical trial activity, seek full reimbursement for our Biosurgery products, and invest in additional product opportunities and research programs. Clinical trials and preclinical studies are time-consuming and expensive. Our expenditures on current and future development programs are subject to many uncertainties. As we obtain results from clinical trials, we may elect to redistribute our resources among trials. 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 the subject of the clinical trial. 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 products needed for clinical trials and regulatory submissions;

† the efficacy and safety profile of the trial subject; and

† the costs and timing of, and the ability to secure, any regulatory approvals we elect to seek.

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 derive benefit from trials involving our Biosurgery products and product candidates.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of the costs associated with our general management, including salaries, sales commissions, allocations of facilities and related costs, and professional fees such as legal and accounting expenses. Beginning in fiscal 2012, we incurred additional selling expenses related to increased distribution efforts for our Biosurgery products. To date in 2013, we have continued to expand our direct sales force to increase distribution volumes of our Biosurgery products directly to end users. 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.

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.


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Provision for Income Taxes

Because realization of deferred tax assets is dependent upon future earnings, a full valuation allowance has been recorded on our net deferred tax assets of $91.4 million, which relate primarily to net operating loss and general business tax credit 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 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 are currently reviewing the applicability of the annual limitation imposed by
Section 382. Existing and future ownership changes may adversely affect our ability to use our remaining net operating loss and tax credits carryforwards. If our ability to use net operating loss and tax credit carryforwards is limited, we may be subject to tax on our income earlier than we would otherwise be had we been able to fully utilize our net operating loss and tax credit carryforwards.

Loss from Operations of Discontinued Operations

As discussed above, on October 10, 2013 we entered into a Purchase Agreement for our culture expanded mesenchymal stem cell business, including Prochymal and other related assets. Accordingly, we have presented the assets, liabilities, and results of the segment's operations as a discontinued operation for all periods presented. Summarized operating results of the Therapeutics segment are presented as loss from operations of discontinued operations in the accompanying financial statements.

Critical Accounting Policies

There have been no material changes in our critical accounting policies, estimates, and judgments during the three and nine months ended September 30, 2013 compared to the disclosures in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2012, other than as disclosed herein.

Results of Operations

Comparison of Three Months Ended September 30, 2013 and 2012

Biosurgery Product Revenues and Gross Profits

Since the launch of our Biosurgery segment, we have continued to expand our distribution efforts, through both in-house personnel and through a distributor network. During the three months ended September 30, 2013, we recognized $6.9 million of product revenues from the distribution of our Biosurgery products, and realized gross profit of $5.0 million. Revenues from the distribution of Biosurgery products in the corresponding period of 2012 were $2.2 million, and gross profit was $1.4 million. A portion of the increase in revenue and gross profit in 2013 is due to volume increases, as we have continued to expand our distribution network. Beginning in 2013, our distribution mix has also shifted more towards direct distribution to end users as compared to those made to stocking distributors for redistribution. Units distributed directly to the end-user have a higher transfer price, which is accompanied by additional selling, general, and administrative expenses in support of those efforts. We expect some fluctuation in the distribution mix between end users and stocking distributors as our Biosurgery segment grows, develops, and introduces new products to the marketplace. Until such time as we ramp up our manufacturing activities to fully utilize our manufacturing facilities and while the distribution mix between end-users and stocking distributors varies, the gross margin we realize on these products is likely to vary significantly. Additionally, 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.

Biosurgery Research and Development Expenses

Research and development expenses (excluding discontinued operations) for the three months ended September 30, 2013 were $885,000 as compared to research and . . .

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