1. Description of Business and Significant Accounting Policies

Description of Business

        Osiris Therapeutics, Inc. ("we," "us," "our," or the "Company") is a Maryland corporation headquartered in Columbia, Maryland. We began operations on December 23, 1992 and were a Delaware corporation until, with approval of our stockholders, we reincorporated as a Maryland corporation on May 31, 2010. We are a leading stem cell company focused on developing and marketing products to treat serious medical conditions in the inflammatory and cardiovascular disease areas, and wound healing. Our biologic drug candidates utilize adult human mesenchymal stem cells, or MSCs, which can selectively differentiate, based on the tissue environment, into various tissue lineages, such as muscle, bone, cartilage, marrow stroma, tendon or fat. In addition, MSCs have anti-inflammatory properties and can prevent fibrosis or scarring, which gives MSCs the potential to treat a wide variety of medical conditions. Historically, our operations have consisted primarily of research, development and clinical activities under several research collaboration agreements to bring our biologic drug candidates to the marketplace. During 2009, we created a Biosurgery business, which in 2010 we began operating as a segment separate from our Therapeutics segment. Our Therapeutics segment is focused on developing and marketing products to treat medical conditions in the inflammatory and cardiovascular disease areas; and our Biosurgery segment focuses on products for wound healing and use in surgical procedures by harnessing the ability of cells and novel constructs to promote the body's natural healing.

Use of Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Due to the inherent uncertainty involved in making those assumptions, actual results could differ from those estimates. We believe that the most significant estimates that affect our financial statements are those that relate to revenue recognition associated with our collaborative agreements, deferred tax assets, inventory valuation, share-based compensation, and the non cash charge associated with the extension of the expiration date of an outstanding warrant discussed below in Note 8.

Cash and Cash Equivalents

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

Investments Available for Sale

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

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

Restricted Cash

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

Accounts Receivable

        Accounts receivable are reported at their net realizable value. We charge off uncollectible receivables when the likelihood of collection is remote. We set credit terms with individual customers, and consider receivables outstanding longer than the time specified in the respective customer's contract, typically 45-days, to be past due. As of December 31, 2011 and 2010, there was no allowance for doubtful accounts related to accounts receivable, as we believe the reported amounts are fully collectible. Accounts receivable balances are not collateralized. We have incurred bad debt expense of $3,000 related to our biosurgery operations during fiscal 2011 and no bad debts expense during the two years ended December 31, 2010.

Inventory

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

        As of December 31, 2011 and 2010, inventory for our Biosurgery segment consists of the following:

        We do not carry any inventory for our Therapeutics products, as none of the products from this segment are currently available for commercial sale. Its operations have focused on clinical trials and discovery efforts to identify additional medical indications. Accordingly, manufactured clinical doses of our drug candidates are expensed as incurred, consistent with our accounting for all other research and development costs.

Property and Equipment

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

Valuation of Long-lived Assets

        We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets. Assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized for the difference between the fair value and carrying value of assets. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. There were no impairment losses recognized during fiscal years 2011, 2010 or 2009.

Revenue Recognition

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

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

        In October 2008, we entered into a Collaboration Agreement with Genzyme Corporation, then an independent and now a Sanofi company ("Genzyme"), for the development and commercialization of our biologic drug candidates, Prochymal® and Chondrogen®. Under this agreement, Genzyme made non-contingent, non-refundable cash payments to us, totaling $130.0 million. The agreement provided Genzyme with certain rights to intellectual property developed by us, and required that we continue to perform certain development work related to the subject biologic drug candidates. As discussed in Note 15, Subsequent Events below, in February 2012, Sanofi issued a press release which included an update on their R&D pipeline, stating that it has "discontinued" its project with Prochymal for GvHD. The statement issued by Sanofi was made without consultation with or knowledge by us. Through our legal counsel, we have advised Sanofi that we are treating these public statements as Sanofi's election to terminate the collaboration agreement. The agreement provides for voluntary termination by Sanofi and that, upon such voluntary termination, all rights to Prochymal revert back to us, and we are free to commercialize or enter into commercialization agreements for Prochymal with other parties without restriction. While we have been proceeding on the basis that Sanofi has terminated the collaboration agreement, Sanofi has since advised us that it disagrees with our characterization of their press release. We have requested an explanation from Sanofi with respect to their statements regarding Prochymal. There can be no assurances as to the outcome of these matters. However, we continue to proceed with our Prochymal regulatory approval efforts and, if successful, commercialization, alone or with another collaborator.

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

        Accordingly, we recognized $40.0 million of revenue in each of the years ended December 31, 2011, 2010, and 2009 related to the amortization of the upfront payments. The balance of these payments has been recorded as $3.3 million of current deferred revenue as of December 31, 2011, that was recognized in January 2012.

        In 2007, we also partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the United States Department of Defense ("DoD") pursuant to which we are seeking, in partnership with Genzyme, to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from acute radiation exposure. We began recognizing revenue under this contract in 2008, and completed our work under the contract during 2010. We have not recognized any revenue associated with this contract during fiscal 2011. Contract revenue was recognized as the related costs are incurred, in accordance with the terms of the contract. We recognized approximately $500,000 and $3.0 million in revenue from the DoD contract during 2010 and 2009, respectively.

        In October 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation ("JDRF") to conduct a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes mellitus. This collaborative agreement provides for JDRF to provide up to $4.0 million of contingent milestone funding to support the development of Prochymal for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. The contingent milestone payments under the agreement are amortized to revenue on a straight line basis over the duration of our obligations under the collaborative agreement as they are received and earned. We have received all $4.0 million of the contingent milestones, and are amortizing the funding received over the duration of our obligations. We began amortizing each payment as it was received, resulting in $1.0 million in revenue during 2011 and $1.2 million of revenue during both 2010 and 2009. We have completed our work under the agreement as of December 31, 2011.

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

        Our Therapeutics segment also earns royalty revenues and cost reimbursement under our adult expanded access program. Royalties are earned on the sale of human mesenchymal stem cells sold for research purposes. We recognize this revenue as sales are made. Revenues include approximately $65,000 of royalty revenue in 2011 and $300,000 of royalty revenue during each of the years 2010 and 2009.

        As discussed in Note 4—Segment Reporting below, in 2010 we began operations of our Biosurgery segment, focused on developing high-end biologic products for use in wound healing and surgical procedures. We commenced the manufacturing of our first Biosurgery product, Grafix®, a regenerative wound care product, during the first quarter of 2010. During the first and second quarters of 2010, we distributed the product only for initial clinical evaluation. We launched the product for limited commercial distribution during the third quarter of 2010. We began distribution of a second Biosurgery product, Ovation® in early fiscal 2011. We recognized revenues of $1,263,000 on distribution of our Biosurgery products in 2011 and $183,000 subsequent to commercial launch in fiscal 2010.

        Due to the conditions required to preserve these products, customers may elect to have the product shipped to them, or we offer the customers use of our specially designed freezers. Legal title passes to the customers when the product either leaves our shipping dock, if the customer has elected to have the product shipped to them, or when it is placed by us in a specifically designated storage unit located at our facility, if they have elected to have us store the product for them. On product stored at our facility, we delay recognition of revenue until such product is shipped to the customer. Due to the nature of the products and the manufacturing process, we do not allow refunds or returns.

Research and Development Costs

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

        Prior to 2010, internal resources were applied interchangeably across several product candidates due to the potential applicability of our biologic drug candidates for multiple indications. Therefore, it was not possible to allocate internal R&D costs on either a project-by-project or product-by-product basis in 2009.

        Beginning in 2010 after the creation of our Biosurgery segment, we began to separately track research and development costs by segment. Total research and development costs for each of our operating segments are as follows:

        As described above, we do not track internal development costs by project within the Therapeutics segment. We do, however, track external research and development costs on a project basis. Our external research and development costs, including third party contract costs, supply and lab costs, and other miscellaneous external costs, for the years ended December 31, 2011 and 2010 are as follows:

Income Taxes

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

        We recognize in our financial statements the impact of a tax position, if that position is more likely than not to be sustained upon an examination, based on the technical merits of the position. Interest and penalties related to income tax matters are recorded as income tax expense. At December 31, 2011 and 2010, we had no accruals for interest or penalties related to income tax matters.

Income per Common Share

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

        Potentially dilutive effects of common share equivalents are calculated based upon the income (loss) from continuing operations.

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

        A reconciliation of basic to diluted weighted average common shares outstanding for 2011 and 2010 is as follows:

        Diluted income per common share excludes all 1,000,762, outstanding stock options for the years ended December 31, 2009, as their effect is anti-dilutive. Similarly, the 1,000,000 shares issuable upon the assumed exercise of outstanding warrant have also been excluded from the calculation as the effect is anti-dilutive. As a result of the anti-dilutive nature of the options and outstanding warrant, basic and diluted income per share are identical for 2009.

Share-Based Compensation

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

        We recognize all share-based payments to employees and non-employee directors in our financial statements based on their grant date fair values, calculated using the Black-Scholes option pricing model. Compensation expense related to share-based awards is recognized on a straight-line basis for each vesting tranche based on the value of share awards that are expected to vest on the grant date, which is revised if actual forfeitures differ materially from original expectations.

Comprehensive Income

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

Concentration of Risk

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

        We have historically provided credit in the normal course of business to contract counterparties and to the distributors of our product. Accounts receivable in the accompanying balance sheets consist primarily of amounts due from distributors of our Biosurgery products. We expect all of our reported receivables to be fully collected. As discussed under "Accounts Receivable" above, we have not incurred material bad debt expense for the three years ended December 31, 2011.

Recent Accounting Guidance Not Yet Adopted at December 31, 2011

        In May 2011, ASU 2011-4, Fair Value Measurement (Topic 820)—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs ("ASU 2011-4") was issued to standardize requirements for measuring and disclosing fair value information under U.S. GAAP and IFRS. This guidance primarily changes the wording used to describe disclosure requirements under U.S. GAAP, but is not intended to change the application of those requirements. ASU 2011-4 is effective for interim or annual periods beginning after December 15, 2011 with early adoption not permitted. Since ASU 2011-4 changes the wording used to describe the fair value disclosure requirements, but does not materially change the actual requirements, the adoption of ASU 2011-4 will not have a material impact on our financial statements.

        In June 2011, ASU 2011-5, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income ("ASU 2011-5") was issued to increase the prominence of items reported in other comprehensive income. Specifically, this guidance requires entities to report all non owner changes in stockholders' equity in either a single continuous statement of comprehensive income or in two separate, but consecutive, statements This guidance eliminates the current financial reporting option for an entity to report the components of other comprehensive income as a part of the statement in changes in stockholders' equity. Further, this guidance requires presentation of all reclassification adjustments between net income and other comprehensive income on the face of the financial statements. ASU 2011-5 is effective for interim or annual periods beginning after December 15, 2011, with early adoption permitted. We will be required to change the format of our financial statements when this guidance becomes effective, and are currently evaluating which of the two permissible formats to use. The adoption of ASU 2011-5 will not have a material impact on our financial position or results of operations.

        In July 2011, ASU 2011-7, Health Care Entities (Topic 954)—Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and Allowance for Doubtful Accounts for Certain Health Care Entities ("ASU 2011-7") was issued to increase the transparency of net patient service revenue and the related allowance for doubtful accounts for health care entities. Specifically, this guidance requires entities to report the provision for bad debts associated with patient service revenue as a deduction from patient service revenues as opposed to as an operating expense. This guidance also requires enhanced disclosures regarding the accounting policies for revenues and assessing bad debts. ASU 2011-7 is effective for interim or annual periods beginning after December 15, 2011, with early adoption permitted. The adoption of ASU 2011-7 will not have a material impact on our financial position or results of operations.

2. Collaboration Agreements and Government Contract

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

        Collaboration Agreement with Genzyme Corporation.    On October 31, 2008, we entered into a Collaboration Agreement with Genzyme for the development and commercialization of Prochymal and Chondrogen. As discussed under Note 15, Subsequent Events below, we have advised Genzyme that we are treating their public statements as election to terminate the Collaboration Agreement. The Collaboration Agreement provides for voluntary termination by Sanofi upon ninety (90) days notice and that, upon such voluntary termination, all rights to Prochymal revert back to Osiris, and Osiris is free to commercialize or enter into commercialization agreements for Prochymal with other parties. As consideration for the rights originally granted to Genzyme under the Collaboration Agreement, they paid us non-contingent, non-refundable cash payments totaling $130.0 million.

        Genzyme Partnership and the United States Department of Defense Contract.    In 2007, we also partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the DoD pursuant to which we, in partnership with Genzyme, are seeking to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from acute radiation exposure. Under the terms of the contract, the DoD will provide funding to us for the development of Prochymal for acute radiation syndrome ("ARS"). This agreement with Genzyme expired in July 2010.

        Juvenile Diabetes Research Foundation Agreement.    In 2007, we entered into a collaborative agreement with the JDRF which provides funding to support the development of Prochymal as a treatment for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. This collaborative agreement provides for JDRF to provide $4.0 million of contingent milestone funding. We initiated a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes in the fourth quarter of 2007, and achieved $2.0 million of the contingent milestones during 2008, $1.5 million in 2009, and the remaining $0.5 million in 2010. Consistent with our revenue recognition policies for such contingent milestones, we began amortizing each milestone payment as it was received and will continue to amortize the payments over the remaining term of our obligations under the agreement.

        JCR Pharmaceuticals Agreement.    In 2003, we entered into a strategic alliance with JCR Pharmaceuticals Co. Ltd. ("JCR"). Under the JCR agreement, we have granted to JCR the exclusive right in Japan to use our technology in conjunction with the treatment of hematologic malignancies using hematopoietic stem cell transplants. The JCR agreement entitles us to a licensing fee and to royalties on any resulting revenue. Upon commencement of the agreement, JCR purchased 545,454 shares of our Series B Convertible Preferred Stock for $3.0 million. These shares were converted into 136,363 shares of our common stock concurrent with our initial public offering in August 2006. They have also paid us a total of $5.0 million in licensing fees under the agreement, $1.0 million in 2010 and $4.0 million of which was prior to 2008. The JCR agreement also provides for additional contingent milestone payments totaling $5.5 million, which will be recorded as revenue if and when the milestone events occur, and as well as royalty payments on sales of the drug in Japan.

3. Discontinued Operations & Gain on Sale of Discontinued Operations

        In July 2005, we began the manufacture and distribution of Osteocel®, which is used by orthopedic surgeons for focal bone repair. In April 2008, we committed to a plan to sell our biologic tissue product segment, including our entire product line relating to the processing, manufacturing, marketing and selling of Osteocel and Osteocel® XO, an allograft material containing cancellous bone, used in spinal fusion and other surgical procedures. We refer to these assets as our Osteocel asset disposal group, and in May 2008, we entered into an Asset Purchase Agreement to sell these assets to NuVasive, Inc., a Delaware corporation. Not included among the Osteocel asset disposal group is Osteocel® XC, our second generation product candidate under development for bone repair, utilizing culture expanded mesenchymal stem cells to create a synthetic version of Osteocel.

        We eliminated the Osteocel asset disposal group from our ongoing operations as a result of the disposal transaction and have presented the results of the group's operations as a discontinued operation for all periods presented.

        The Asset Purchase Agreement to sell the Osteocel asset disposal group to NuVasive provided for two closings—a technology assets closing, at which technology and certain other business assets were transferred, and a manufacturing assets closing, at which manufacturing assets and facilities were to be transferred. In July 2008, we held a Special Meeting of Stockholders at which our stockholders overwhelmingly approved the sale of the Osteocel business. The technology assets closing also occurred on that date, at which time we received an initial payment of $35.0 million. Concurrent with the technology assets closing, we entered into a Manufacturing Agreement with NuVasive, under which we continued to manufacture Osteocel and sold 100% of the product to NuVasive at specified prices.

        In March 2009, we entered into further amendments to the Asset Purchase Agreement and the related Manufacturing Agreement, as a result of which the manufacturing assets closing was accelerated and all performance conditions to receipt, by us, of $30.0 million of contingent milestone payments were removed. As a result, those payments became payable at specified dates, without regard to other conditions, either in cash or in shares of NuVasive stock, at the option of NuVasive.

        The Asset Purchase Agreement, as amended, provided for up to $85.0 million of total purchase price, as follows:

        The $30.0 million of payments that became payable at specified dates (March, June and September 2009, respectively) as a result of the March 2009 amendments, net of direct expenses of approximately $0.2 million, were recorded as a component of the gain on the sale of discontinued operations in the first quarter of 2009. The $12.5 million payments due June 30, 2009 and September 30, 2009, as well as the final $15.0 million milestone achieved in October 2009, were paid in shares of common stock issued by NuVasive. Cumulatively, we received 1,001,422 shares of NuVasive common stock, of which we had sold 986,122 for total cash proceeds of approximately $40.3 million at December 31, 2009. At December 31, 2009, we had the remaining 15,300 shares, with a fair value of $489,000, included on our balance sheet as a component of Investments Available for Sale. We sold these shares in 2010 for additional cash proceeds of approximately $598,000, which included a realized gain of approximately $24,000. Title to the fixed assets passed to NuVasive on April 9, 2009.

        As stipulated under the March 2009 amendments, we ceased manufacturing Osteocel on March 28, 2009. As a result of this cessation of manufacturing, we committed to a workforce reduction of the approximately 80 employees involved in the Osteocel business. Employees directly affected by the workforce reduction received notification on March 30, 2009, and the workforce reduction was substantially completed in the second quarter of 2009. All of the affected employees received severance benefits, comprised principally of severance, benefits continuation costs and outplacement services. Total one-time termination benefits for the reduction in force totaled approximately $1.4 million, which was recorded as a component of the gain on the sale of discontinued operations in the first quarter of 2009.

        Also in connection with the March 2009 amendments, we relieved NuVasive of its obligation to assume the lease for our Columbia, Maryland facility. As a result of the combination of our cessation of Osteocel manufacturing and retaining the lease obligations for the Columbia, Maryland facility, we conducted an analysis of our future minimum lease payments for the facility, related to unutilized space, and recorded an impairment charge of approximately $3.2 million related to our future minimum lease payments. Additionally, we recorded an impairment of the leasehold improvements specifically related to Osteocel production of approximately $3.0 million.

        As discussed below in Note 4—Segment Reporting, we created a new Biosurgery segment at the end of the third quarter of 2009, which utilizes the facilities previously used to manufacture Osteocel. As a result, we updated our analysis of the lease impairment charge and reversed the $2.8 million impairment that remained unamortized at that time. Both of these impairments charges were recorded as components of the gain on the sale of discontinued operations in 2009.

        Also as a result of acceleration of the manufacturing assets closing, during the first quarter of 2009 we reversed approximately $2.5 million of concessionary pricing reserves for future Osteocel production that had been established under the original Manufacturing Agreement.

        The fair value of the property that we transferred on the date of the manufacturing assets closing in April 2009, including both the manufacturing assets transferred to NuVasive and the inventory transferred to AlloSource, was approximately $5.1 million.

        Since the transaction was completed as of December 31, 2009 the Osteocel asset disposal group did not have an impact on our statement of operations during fiscal 2011 or 2010.

        We recognized a gain of approximately $37.1 million, net of income taxes, on the sale of discontinued operations for the year ended December 31, 2009, summarized as follows:

        The only assets allocable to the Osteocel asset disposal group at December 31, 2009 were $412,000 of current liabilities, all of which were settled during the first quarter of 2010.

        Summarized operating results of the Osteocel asset disposal group for the years ended December 31, 2009 are as follows:

        Revenues on Osteocel products were recognized when legal title passed to the customer. Costs related to the Osteocel product consist primarily of the costs to obtain the tissue and other chemicals and supplies, quality and sterility testing, plus labor and allocated overhead costs and the costs of operating the clean-room facilities.

4. Segment Reporting

        At the end of the third quarter of 2009, we created the Biosurgery division, focused on developing high-end biologic products for use in surgical procedures.

        In 2010, we began to manage our business in two reportable operating segments: the Therapeutics segment and the Biosurgery segment. Our Therapeutics segment focuses on developing and marketing products to treat medical conditions in the inflammatory, autoimmune, orthopedic and cardiovascular areas. Its operations have focused on clinical trials and discovery efforts to identify additional medical indications. Our Therapeutics segment does not presently have any products approved for sale and its revenues consist of collaborative research agreements, a government contract and royalties as described in Note 1—Description of Business and Significant Accounting Policies.

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

        Substantially all of our revenues and assets are attributed to and are received from entities located in the United States.

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

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

        The assets specifically attributable to each of our segments as of December 31, 2011 and 2010 are as follows:

5. Property and Equipment

        Property and equipment at December 31, 2011 and 2010 are as follows:

6. Share-Based Compensation

        In April 2006, we adopted our 2006 Omnibus Plan. We amended and restated this plan in 2008 and again in 2010 to, among other things, increase the number of shares available for grant. In addition, we had previously established our Amended and Restated 1994 Stock Incentive Plan. Both Plans authorize the issuance of various forms of stock-based awards, including incentive and non-qualified stock options, stock purchase rights, stock appreciation rights and restricted and unrestricted stock awards. A total of 1,950,000 shares of our common stock have been reserved for issuance under the Amended and Restated 2006 Omnibus Plan, and 736,378 shares were reserved under our Amended and Restated 1994 Stock Incentive Plan. We ceased all grants under the Amended and Restated 1994 Stock Incentive Plan concurrent with our initial public offering in August 2006. As a result, no shares are currently available for future awards under the Amended and Restated 1994 Stock Incentive Plan. At December 31, 2011, there were 420,948 shares available for future awards under the Amended and Restated 2006 Omnibus Plan.

        We generally issue stock option awards that vest over four years and have a ten-year contractual life. We estimate the fair value of stock options using the Black-Scholes option-pricing model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. The fair value of stock options granted during each of the periods was estimated using the following assumptions:

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

        In connection with the stock options exercised during the year ended December 31, 2011, we received cash proceeds of $22,000. At December 31, 2011, there was $1.3 million of total unrecognized compensation costs related to non-vested stock options, which is expected to be recognized over a weighted average period of 0.75 years.

        A summary of stock option activity for the years ended December 31, 2011, 2010 and 2009 is as follows:

        A summary of stock options outstanding at December 31, 2011, by price range is as follows:

        The weighted fair value of options granted during the years ended December 31, 2011, 2010, and 2009 were $3.50, $3.77, and $9.26, respectively.

        The table below reflects the total share-based compensation expense (including share-based payments to our non-employee directors, but excluding the non cash expense related to the extension of the expiration date of an outstanding warrant as discussed in Note 8 below) recognized in our income statements for the years ended December 31, 2010, 2009 and 2008. For the years ended December 31, 2011, 2010, and 2009, share-based compensation expense is based on awards ultimately expected to vest.

7. Related Party Transactions

        Peter Friedli.    Peter Friedli, the Chairman of our Board of Directors, or entities with which he is affiliated, have been responsible for procuring since 1993, an aggregate of approximately $270 million in debt and equity financing for us and our predecessor company. Mr. Friedli is the beneficial owner of approximately 47% of our common stock as of December 31, 2011. Of the shares beneficially owned by Mr. Friedli at December 31, 2011, 55,000 shares were received by him as Board compensation since 1996, 12,500 shares and warrants for 1,000,000 shares were granted in recognition of his fundraising efforts, as discussed below, and the remaining shares were acquired through investment or through purchase from third parties.

        During 2010, we paid Mr. Friedli $64,600 for his service on our Board of Directors. In 2011, we issued 10,000 shares of our common stock, valued at $71,000 to Mr. Friedli for his service on our Board of Directors and in 2009; we issued 10,000 shares of our common stock, valued at $120,000 to Mr. Friedli for his service on our Board of Directors.

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

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

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

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

        Prolexys is 37.7% owned by BIH SA, which owns 8.2% of our outstanding common stock; 23.7% owned by Peter Friedli who is the Chairman of our Board of Directors and direct owner of 30.8% of our common stock; and 14.6% owned by Venturetec, Inc., which holds 12.7% of our common stock. Peter Friedli is the President and a 3% owner of Venturetec, Inc. Lode Debrabandere, our Senior Vice President of Therapeutics, serves on the Board of Directors of Prolexys, but has no other interest therein.

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

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

8. Warrants

        As discussed in Note 7 above, at December 31, 2011, we had an outstanding warrant to purchase 1,000,000 shares of our common stock at an exercise price of $11.00 per share. As of December 31, 2011, a summary of the status of the warrant is as follows:

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

9. Income Taxes

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

        The provision for income taxes in 2010 represents the U.S. Federal income tax of $2.7 million, Maryland state income taxes of $1.2, net of the valuation allowance release of $3.2 million and the true-up of our income tax payable account to the 2009 income tax returns and is $241,000. The provision for income taxes in 2009 represents the U.S. Federal alternative minimum tax of $1.6 million on our taxable income. Our 2009 total tax expense comprises of the income tax benefit of $2.7 million from our continuing operations and the tax expense of $4.3 million on the gain from the discontinued operations.

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

        Non-deductible expenses represent primarily research and development expenses for which we claimed the orphan drug credit and non-cash share based compensation for each of the three years ended December 31, 2011.

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

        During 2011, we recognized $2.2 million of our net deferred tax assets related to timing differences in the recognition of deferred revenue related to our collaboration agreement with Genzyme for financial reporting and income tax purposes. We expect to realize this deferred tax asset during 2012. We presently have available for federal income tax purposes, approximately $76.3 million of research and experimentation credit carry-forwards, which expire beginning in 2026 through 2031. In addition, we expect to have approximately $3.4 million of federal net operating loss carryforwards as of December 31, 2011, which will begin to expire in 2031. In 2010, we were subject to the alternative minimum tax. In 2011, we were not subject to the alternative minimum tax due to having a net loss for tax purposes. In the future, we may be subject to the alternative minimum tax regardless of our net operating loss carry-forwards.

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

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

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

10. Defined Contribution Plan

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

11. Commitments and Contingencies

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

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

        As of December 31, 2011, we had active contracts with CROs related to three on-going clinical trials which were in varying stages of completion. The total contracted payments to CROs under these agreements were $24.3 million, of which we had incurred approximately $18.1 million as of that date. Although we cannot directly control the timing of the remaining payments, based on our estimates and assumptions as of December 31, 2011, we expect to pay our remaining obligations of $6.2 million to these CROs during 2012.

        Subsequent to December 31, 2011, we have contracted with a CRO to perform a clinical trial for our Biosurgery segment. This contract provides for total costs of approximately $4.5 million over a period of approximately 2.5 years. Since the CRO has not yet begun work under this contract, we are unable to accurately predict the timing of these payments at this time.

        Leases.    During 2006, we entered into a sublease agreement for approximately 61,000 square feet of laboratory, production, warehouse and office space in Columbia, Maryland. We have also entered into a direct lease with the owner of this facility that was effective as of June 1, 2009 upon the expiration of the sublease and expires in July 2016. During 2009, following the expiration of the sublease agreement, we increased an outstanding letter of credit, which was used in lieu of a security deposit for this lease, to $591,000 according to the terms of the direct lease with the owner of the facility. At each of July 1, 2011 and 2010, the security deposit required under this lease decreased to $372,000 and $446,000, respectively. We reduced our outstanding letter of credit accordingly, and the reduced letter of credit of $372,000 remained outstanding as of December 31, 2011, and has been fully collateralized by restricted cash.

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

        Our expenses under this lease were $1.2 million, $1.3 million, and $957,000, during 2011, 2010, and 2009, respectively.

        Historically, we also have entered into various financing arrangements to lease laboratory and other equipment. The terms of these facilities and equipment leases are considered capitalized leases, and accordingly $26,000 of equipment acquired under these agreements, which had been fully depreciated as of December 31, 2010, is included in our balance sheets at both December 31, 2011 and 2010.

        There are no remaining minimum lease payments under these capitalized facilities and equipment arrangements as of December 31, 2011.

        Technology Transfer and License Agreement.    In 1994, we entered into a Technology Transfer and License Agreement with Case Western Reserve University ("CWRU") under which we purchased rights to certain mesenchymal stem cell and related technology and patents. We are required to pay royalties on revenues related to CWRU developed technology, with minimum royalties of $50,000 per year. We paid CWRU $50,000 in each of the years 2011, 2010, and 2009, under this agreement.

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

12. Investments Available for Sale

        Investments available for sale consisted of the following as of December 31, 2011 and 2010: