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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

FOR THE QUARTERLY PERIOD ENDED September 30, 2014,

OR

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

FOR THE TRANSITION PERIOD FROM            TO           

Commission file number 0-22025

AASTROM BIOSCIENCES, INC.

(Exact name of registrant as specified in its charter)

(800) 556-0311

(Registrant’s telephone number, including area code)

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

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

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.

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AASTROM BIOSCIENCES, INC.

QUARTERLY REPORT ON FORM 10-Q

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PART I - FINANCIAL INFORMATION

Item 1.                                                         Financial Statements

AASTROM BIOSCIENCES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, amounts in thousands)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

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AASTROM BIOSCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, amounts in thousands except per share amounts)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

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AASTROM BIOSCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited, amounts in thousands)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

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AASTROM BIOSCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, amounts in thousands)

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE QUARTER ENDED SEPTEMBER 30, 2014 (UNAUDITED)

NOTE 1— ORGANIZATION:

Aastrom Biosciences, Inc. (the Company or Aastrom) was incorporated in March 1989 and began employee-based operations in 1991. On May 30, 2014 Aastrom completed the acquisition of certain assets of Sanofi, a French société anonyme (Sanofi), including all of the outstanding equity interests of Genzyme Biosurgery ApS (Genzyme Denmark), a wholly-owned subsidiary of Sanofi, and over 250 patents and patent applications of Sanofi and certain of its subsidiaries and assumed certain liabilities for purposes of acquiring the portion of the cell therapy and regenerative medicine business (the CTRM Business), which researches, develops, manufactures, markets and sells Carticel, MACI and Epicel (the CTRM Transaction). The CTRM Business researches, develops, manufactures, markets and sells the Carticel®, MACITM and Epicel® products. As a result, the Company exited the development stage, and is now a fully integrated, commercial-stage biopharmaceutical company dedicated to the identification, development and commercialization of innovative therapies that enable the body to repair and regenerate damaged tissues and organs to restore normal structure and function.  Aastrom has marketed products as well as developmental stage product candidates and the Company’s goal is to become the leader in cell therapy and regenerative medicine by developing, manufacturing and marketing best-in-class therapies for patients with significant unmet medical needs.

The Company operates its business in one reportable segment — the research, product development, manufacture and distribution of patient-specific, expanded cellular therapies for use in the treatment of specific diseases.

Successful future operations are subject to several technical hurdles and risk factors, including satisfactory product development, timely initiation and completion of clinical trials, regulatory approval and market acceptance of the Company’s products, and the successful integration and profitability of the CTRM Business.

NOTE 2 — BASIS OF PRESENTATION:

The condensed consolidated financial statements included herein have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC).  The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States of America (U.S. GAAP) requires management to make estimates, judgments, and assumptions that may affect the reported amounts of assets, liabilities, equity, revenues and expenses. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been omitted pursuant to such rules and regulations. The financial statements reflect, in the opinion of management, all adjustments (consisting only of normal, recurring adjustments) necessary to state fairly the financial position and results of operations as of and for the periods indicated.  The results of operations for the nine months ended September 30, 2014, are not necessarily indicative of the results to be expected for the full year or for any other period.  The December 31, 2013 condensed consolidated balance sheet data was derived from the Company’s audited consolidated financial statements, but does not include all disclosures required by U.S. GAAP.

These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the period ended December 31, 2013, as filed with the SEC on March 13, 2014 (Annual Report).

The consolidated financial statements include the accounts of Aastrom and its wholly-owned subsidiaries, Aastrom Biosciences GmbH, located in Berlin, Germany, Marrow Donation, LLC, located in San Diego, California, and Aastrom Biosciences DK ApS, in Kastrup, Demark (collectively, the Company).  All inter-company transactions and accounts have been eliminated in consolidation.  Aastrom Biosciences GmbH has ceased operations.

NOTE 3 —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NEWLY ISSUED ACCOUNTING STANDARDS:

During the nine months ended September 30, 2014, the Company added certain policies and procedures as a result of its acquisition of the commercialized CTRM Business.  There were no other changes to the significant accounting policies described in the Company’s audited financial statements as of and for the year ended December 31, 2013, and the notes thereto, which are included in the Annual Report.

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Inventory

Inventories are measured at the lower of cost or market value. Cost is calculated using the first-in, first-out method.  Utilization reserves are established for estimated obsolescence or un-marketable inventory in an amount equal to the cost of inventory.

Accounts Receivable

Accounts receivable is initially recorded at the contractual amount owed by the customer.  Allowances for doubtful accounts are established when the facts and circumstances indicate that a receivable may not be collectible.

Property, Plant and Equipment

Property, plant and equipment are initially measured and recognized at acquisition cost, including any directly attributable cost of preparing the asset for its intended use or, in the case of assets acquired in a business combination, at fair value as at the date of the combination.

After initial measurement, property, plant and equipment are carried at cost less accumulated depreciation and impairment.

Repair and maintenance costs of property, plant and equipment are expensed as incurred.

The depreciable value of property, plant and equipment, net of any residual value, is depreciated on a straight line basis over the useful life of the asset. The useful life of an asset is usually equivalent to its economic life.

The useful lives of property, plant and equipment are as follows:

·                  Equipment and computers:  3 to 5 years

·                  Furniture and fixtures:  5 years

·                  Building improvements and leasehold improvements:  Shorter of the remaining life of the lease or 15 years

Useful lives and residual values of property, plant and equipment are reviewed periodically. The effect of any adjustment to useful lives or residual values is recognized prospectively as a change of accounting estimate.

Intangible Assets

Intangible assets are initially measured at acquisition cost, including any directly attributable costs of preparing the asset for its intended use or, in the case of assets acquired in a business combination at fair value as at the date of the combination.  Identifiable intangible assets related to product rights are amortized on a straight line basis over their expected useful lives.

The useful lives of intangible assets are reviewed periodically.  The effect of any adjustment to useful lives is recognized prospectively as a change of accounting estimate.

Amortization of intangible assets is recognized in these financial statements under Costs of product sales.

Intangible assets are carried at cost less accumulated amortization and impairment.

Impairment of Intangible Assets and Other Long-Lived Assets

Intangible assets and long-lived assets are assessed for potential impairment when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. An impairment loss would be recognized when an asset’s fair value, determined based on undiscounted cash flows expected to be generated by the asset, is less than its carrying amount. The impairment loss would be measured as the amount by which the asset’s carrying value exceeds its fair value and recognized in these financial statements.

Foreign Currency Translation

Assets and liabilities of Genzyme Denmark are translated from Danish Krone into U.S. dollars using the applicable exchange rates in effect at the period end.  Expenses of the operations in Denmark are translated from the applicable currencies into U.S. dollars using average exchange rates for the reported period.

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Revenue Recognition

Total revenues are comprised of product sales of Carticel, Epicel, MACI, bone marrow, and surgical kits.  Revenue is recognized when persuasive evidence of an arrangement exists, the goods are shipped or delivered, depending on shipping terms, title and risk of loss pass to the customer and collectability is reasonably assured.

Revenue is recorded net of a provision, made at the time of sale, for rebates and cash discounts. These revenue reductions are established by the Company at the time of sale, based on historical experience adjusted to reflect known changes in the factors that impact such reserves.  Distributors are entitled to chargeback incentives for services that are provided for based on the selling price to the end customer, under specific contractual arrangements. Cash discounts may also be granted for prompt payment.

Research and Development Expense

Research and development activities represent a significant part of the Company’s business.  These expenditures relate to the development of new products, improvement of existing products, technical support of products and compliance with governmental regulations for the protection of consumers and patients.  Research and development expenses are expensed as incurred.

Newly issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 merges revenue recognition standards of the FASB and International Accounting Standards Board (IASB). The FASB and IASB initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards (IFRS) that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosure requirements; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2016, and interim periods within those annual periods. The Company is currently evaluating the potential impact of this new guidance on its consolidated financial statements.

NOTE 4—ACQUISITIONS:

CTRM Business acquisition

On May 30, 2014, Aastrom completed its acquisition of certain assets of Sanofi, including all of the outstanding equity interests of Genzyme Denmark, a wholly-owned subsidiary of Sanofi, and over 250 patents and patent applications and assumed certain liabilities for purposes of acquiring portions of the CTRM Business.  Aastrom is a leading developer of patient-specific, expanded multicellular therapies for the treatment of severe, chronic cardiovascular diseases.  The CTRM Business, also a leading developer of patient-specific expanded cellular therapies, expands the Company’s portfolio of cellular therapies to include products which treat severe burns and as well as cartilage defects.  The CTRM Business is a commercial business, with manufacturing, marketing and sales capabilities.  Pursuant to the terms of the asset purchase agreement, the Company paid a total purchase price of $6.5 million, including $4.0 million in cash and a $2.5 million promissory note which was repaid on July 30, 2014.

The total purchase price consideration is as follows:

The Company recognized tangible and intangible assets and liabilities acquired based upon their respective estimated fair values as of the acquisition date. The table below shows the preliminary fair values assigned to the assets acquired and liabilities assumed. Based on this analysis, the transaction resulted in a bargain purchase gain. We may make additional adjustments to the fair values, and these valuations could change significantly from those used to determine certain adjustments in the pro forma condensed combined financial statements.

The preliminary purchase price allocation is as follows:

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As part of the acquisition, $5.0 million in cash was received from Sanofi in order to fund the restructuring of the Denmark operations and close the facility.  To date we have recorded restructuring charges of $3.1 million and may incur additional costs in the fourth quarter of 2014.  See Note 5 “Restructuring” below for additional information.

The intangible assets acquired represent commercial use rights for certain products acquired in the transaction. This estimated fair value was determined using the income approach based on projected cash flows attributed to the commercial rights. The calculated value of the commercial rights intangible assets are amortized using the straight line method over an estimated useful life of twelve years.

The identifiable intangible assets acquired and their estimated useful lives are summarized as follows:

Revenue and net loss included in the condensed consolidated financial statements include four months of operations related to the CTRM Business since the May 30, 2014 acquisition and are $13.8 million and $(1.7 million), respectively. The net loss related to the CTRM Business includes the restructuring costs of $3.1 million described below as well as $0.8 million of expenses from the Denmark subsidiary that the Company is in the process of shutting down.

The following unaudited pro forma condensed combined information for the nine month periods ended September 30, 2014, and 2013, respectively are presented as if the acquisition of the CTRM Business had occurred on January 1, 2013.

These unaudited pro forma condensed combined statements should be read in connection with the Company’s historical combined financial statements and notes thereto filed with the SEC. In management’s opinion, all adjustments necessary to reflect the significant effects of this transaction have been made. These statements are based on assumptions and estimates considered appropriate by our management; however, they are not necessarily, and should not be assumed to be, an indication of our financial position or results of operations that would have been achieved had the acquisitions been completed as of the dates indicated or that may be achieved in the future.

NOTE 5—RESTRUCTURING:

On June 16, 2014, the Company announced a strategic plan to maximize the profitability and growth potential of the CTRM Business (the Plan).  Under the Plan, the Company discontinued manufacturing MACI in Denmark, temporarily ceased sales of MACI in Europe, and significantly reduced research and development expenses associated with MACI.  Furthermore, the Company has eliminated approximately 80 full time employee positions, which represented approximately 30% of the Company’s current total workforce.  Employees terminated as part the Plan were provided with severance payments and outplacement assistance.

As a result of the Plan, the Company recorded a restructuring charge of $0.1 million and $3.1 million in the three and nine months ended September 30, 2014, respectively, related to the operations in the United States and Denmark, primarily representing cash

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payments for severance and other personnel-related expenses.  Of the total restructuring charge, $2.5 million was recorded in cost of product sales, and $0.6 million was recorded in selling, general and administrative expenses. The restructuring reserve decreased to $0.9 million as of September 30, 2014 as a result of cash payments made for severance and other personnel-related expenses. In addition to restructuring charges recorded thus far, the Company may incur additional lease termination costs and stay-on bonuses associated with future restructuring actions. The Company currently expects to complete the Plan by the end of the fourth quarter of 2014.  The Company acquired an asset retirement obligation of $1.6 million related to the obligation to restore the Denmark facility to its original state. The Company is currently attempting to sell the leasehold improvement and transfer the lease obligation in order to avoid incurring the restoration costs.

Any additional restructuring costs will be recognized when management finalizes and approves the additional restructuring activities.  These costs will be recognized when appropriate.

NOTE 6 — STOCK—BASED COMPENSATION

The Company issues nonqualified and incentive stock options as well as other equity awards pursuant to its Amended and Restated 2009 Omnibus Incentive Plan, (Option Plan).  Such awards pursuant to the Option Plan may be granted by the Company’s Board of Directors to certain of the Company’s employees, directors and consultants.

During the three and nine months ended September 30, 2014, the Company granted zero and 242,025, respectively, service-based options to purchase common stock.  These options were granted with exercise prices equal to the fair market value of the Company’s stock at the grant date, generally vest over four years and expire after ten years.  The weighted average grant-date fair value of service-based options granted under the Option Plan during the three month period ended September 30, 2013 was $5.11.  The weighted average grant-date fair value of service-based options granted under the Option Plan during the nine month periods ended September 30, 2014 and 2013 was $2.85 and $14.07, respectively.

The net compensation expense recorded for the service-based stock options related to employees and directors was $0.2 million and $0.7 million for the three and nine months ended September 30, 2014, respectively, compared to $0.1 million and $0.5 million for the three and nine month periods ended September 30, 2013, respectively.  The compensation cost includes forfeiture adjustments.

The fair value of each service-based stock option grant for the reported periods is estimated on the date of the grant using the Black-Scholes option-pricing model using the weighted average assumptions noted in the following table.

The following table summarizes the activity for service-based stock options for the indicated periods:

As of September 30, 2014 there was approximately $1.1 million of total unrecognized compensation cost related to non-vested service-based stock options granted under the Option Plan.  That cost is expected to be recognized over a weighted-average period of 2.92 years.

The total fair value of options vested during the nine months ended September 30, 2014 and 2013 was $1.3 million and $1.9 million, respectively.

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NOTE 7—BALANCE SHEET COMPONENTS:

Inventory:

Property and equipment, net:

Intangible assets, net:

Amortization expenses were $0.07 million and $0.1 million for the three and nine month periods ended September 30, 2014, respectively. There was no amortization expense in the three and nine month periods ending September 30, 2013. The increase in intangible assets, net from December 31, 2013 to September 30, 2014 is due to the acquisition of the CTRM Business.

Estimated future amortization expense is as follows:

Accounts payable and accrued expenses:

Restructuring reserve and asset retirement obligation:

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Accumulated other comprehensive income:

Accumulated other comprehensive income consists entirely of foreign currency translation activity.  There were no reclassifications out of other comprehensive income during the three or nine months ending September 30, 2014.

NOTE 8—FAIR VALUE MEASUREMENTS:

The Company’s fair value measurements are classified and disclosed in one of the following three categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability;

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

The following table summarizes the valuation of the Company’s investments and financial instruments that are measured at fair value on a recurring basis:

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The following table summarizes the change in the estimated fair value of the Company’s warrant liabilities:

A reconciliation of beginning and ending balances for the Company’s fair value measurements using Level 3 inputs is as follows:

Warrants:

NOTE 9—STOCK PURCHASE WARRANTS:

The Company has historically issued warrants to purchase shares of the Company’s common stock in connection with certain of its common stock offerings.  The following warrants were outstanding at September 30, 2014, and include provisions that could require cash settlement of the warrants or have anti-dilution price protection provisions requiring each to be recorded as liabilities of the Company at the estimated fair value at the date of issuance, with changes in estimated fair value recorded as non-cash income or expense in the Company’s statement of operations in each subsequent period:

The fair value of the Class A warrants and the December 2010 warrants are measured using the Monte Carlo valuation model.  The methodology is based, in part, upon inputs for which there is little or no observable market data, requiring the Company to develop its own assumptions. The assumptions used in calculating the estimated fair value of the warrants represent the Company’s best estimates, however; these estimates involve inherent uncertainties and the application of management judgment.  As a result, if factors change and different assumptions are used, the warrant liabilities and the change in estimated fair value of the warrants could be materially different.  The August 2013 warrants are valued using a Black-Scholes valuation model.

Inherent in the Monte Carlo and Black-Scholes valuation models are assumptions related to expected stock-price volatility, expected life, risk-free interest rate and dividend yield.  The Company estimates the volatility of its common stock based on historical volatility that matches the expected remaining life of the warrants.  The risk-free interest rate is based on the U.S. Treasury zero-coupon yield curve on the grant date for a maturity similar to the expected remaining life of the warrants.  The expected life of the warrants is assumed to be equivalent to their remaining contractual term.  The dividend rate is based on the historical rate, which the Company anticipates to remain at zero.

The Monte Carlo model is used for the Class A warrants and the December 2010 warrants to value the potential future exercise price adjustments triggered by the anti-dilution provisions as well as the value of the put feature of the December 2010 warrants.  These require Level 3 inputs which are based on the Company’s estimates of the probability and timing of potential future financings and fundamental transactions.  The other assumptions used by the Company are summarized in the following tables:

The assumptions used by the Company are summarized in the following tables:

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NOTE 10—SERIES B CONVERTIBLE PREFERRED STOCK:

On March 9, 2012, the Company completed the sale of 12,308 shares of Series B-1 Non-Voting Convertible Preferred Stock (Series B-1 preferred stock) at an offering price of $3,250 per share.  In addition to the Series B-1 preferred stock, which was issued at the closing, the Company also authorized Series B-2 Voting Convertible Preferred Stock (Series B-2 preferred stock).  The Series B-1 preferred stock and Series B-2 preferred stock collectively are referred to as the Series B preferred stock.  The Series B preferred stock is convertible, at the option of the holder thereof at any time after the five year anniversary of the closing of the offering, (the Conversion date) into shares of common stock at a conversion price of $3.25 per share of common stock.  At any time after the Conversion date, the Company may elect to convert any or all outstanding shares of Series B preferred stock into shares of common stock, subject to certain limitations.  Stock dividends on the Series B preferred stock will be cumulative and compound daily, at a rate of 11.5% per annum, payable upon conversion, liquidation, redemption or other similar events, and payable in cash or Series B-1 preferred stock until the Conversion date.  As of September 30, 2014, there are approximately 210,782 shares of accumulated but undeclared Series B-1 Stock dividends.  Unless prohibited by Michigan law governing distributions to shareholders, the Series B-1 preferred stock shall be redeemable at the option of holder of the Series B-1 preferred stock commencing at any time after the Conversion date, liquidation, winding up, dissolution or other similar events, subject to certain terms and limitations.

The Series B preferred stock does not, in its entirety, require liability classification and was evaluated for embedded features to determine if those features require bifurcation and separate classification as derivative liabilities.  The Series B preferred stock host contract was evaluated for equity or mezzanine classification based upon the nature of the redemption and conversion features.  Generally, any feature that could require cash redemption for matters not within the Company’s control, irrespective of probability of the event occurring, requires classification outside of shareholders’ equity.  The Series B preferred stock was initially recorded as mezzanine in the Condensed Consolidated Balance Sheets and was accreted to its redemption value through charges to accumulated deficit using the effective interest method.

On August 12, 2013, the Company amended the Series B preferred stock agreement to remove the cash redemption provision, modify the liquidation preferences for the Series B-2 preferred stock and to increase the redemption price for the Series B-1 preferred stock.  The redemption price, prior to the five year anniversary, is now equal to $7,430 multiplied by the number of Series B-1 preferred shares redeemed minus the Company’s closing stock price multiplied by the number of common shares into which the outstanding Series B-2 preferred stock are convertible.  The redemption price, after the five year anniversary, is the amount equal to the greater of the Series B offering price plus accrued dividends or the conversion value in common stock.  As a result of the amendment to the agreement, the total amount of $38.4 million Series B preferred stock was reclassified from mezzanine into shareholders’ equity.

NOTE 11—NET LOSS PER COMMON SHARE:

Basic earnings (loss) per share is calculated using the two-class method, which is an earnings allocation formula that determines earnings (loss) per share for the holders of the Company’s common shares and holders of the Series B preferred stock.  The Series B preferred stock shares contain participation rights in undistributed earnings, but do not share in the losses of the Company.  The dividends on the Series B preferred stock are treated as a reduction of earnings attributable to common shareholders.

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The following reflects the net loss attributable to common shareholders and share data used in the basic and diluted earnings per share computations using the two class method:

Common equivalent shares are not included in the diluted per share calculation where the effect of their inclusion would be anti-dilutive.  The aggregate number of common equivalent shares (related to options, warrants and preferred stock) that have been excluded from the computations of diluted net loss per common share at September 30, 2014 and 2013 were 2.3 million and 2.4 million, respectively.

NOTE 12—SHAREHOLDERS’ EQUITY:

On September 17, 2014, the Company closed on a public equity offering whereby it sold 15,784,313 shares of common stock at an offering price of $2.55 per share (the 2014 offering).  The proceeds of $37.5 million, net of $2.4 million of underwriters’ discount and $0.3 million of issuance costs consisting primarily of legal and accounting fees, were recorded as a common stock issuance.

On July 9, 2014, the Company entered into a Warrant Exercise Agreement with one holder of warrants issued by the Company on August 16, 2013 (the 2013 Warrants) to purchase an aggregate of 362,500 shares of the Company’s common stock, no par value.  Pursuant to the Warrant Exercise Agreement, the holder agreed to exercise the 2013 Warrants at the existing exercise price of $4.80.  The net proceeds to the Company in connection with the exercise of the 2013 Warrants, after deducting a warrant inducement payment and expenses, were approximately $1.5 million.

On January 21, 2014, the Company entered into a purchase agreement (Purchase Agreement), together with a registration rights agreement, for the sale of up to $15.0 million of shares of its common stock to Lincoln Park, subject to certain limitations, from time to time over a 30-month period, which began on April 3, 2014 and ends on October 3, 2016.

The Company may direct Lincoln Park, at its sole discretion, to purchase up to 50,000 shares of common stock in regular purchases, increasing to amounts of up to 100,000 shares depending upon the closing sale price of the common stock.  In addition, the Company may direct Lincoln Park to purchase additional amounts as accelerated purchases if on the date of a regular purchase the closing sale price of the common stock equals or exceeds $3.00 per share.  The purchase price of shares of common stock related to the future funding will be based on the prevailing market prices of such shares at the time of sales (or over a period of up to 10 business days leading up to such time), but in no event will shares be sold to Lincoln Park on a day the common stock closing price is less than the floor price of $2.50, subject to adjustment.  The Company controls the timing and amount of any sales of common stock to Lincoln Park. The Company’s sales of shares of common stock to Lincoln Park under the Purchase Agreement are limited to no more than the number of shares that would result in the beneficial ownership by Lincoln Park and its affiliates, at any single point in time, of more than 9.99% of the then outstanding shares of the common stock.

In connection with the Purchase Agreement, in the nine months ended September 30, 2014, the Company issued to Lincoln Park 935,499 shares of common stock and raised gross proceeds of $3.7 million (with a remaining balance of $11.3 million).  Additionally, during the nine months ended September 30, 2014, the Company raised net proceeds of $7.1 million utilizing the At-the-Market Sales Agreement (ATM) with MLV & Co. LLC (formerly McNicoll, Lewis & Vlak). At September 30, 2014 there was approximately $7.8 million of net capacity remaining on the ATM.

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NOTE 13—CONCENTRATION OF CREDIT RISK

Revenue from one customer, a distributor in the U.S., represented approximately 75% of total revenue during the three and nine months ended September 30, 2014.  Excluding that distributor, the largest customer represented approximately 10% of revenue for the three month period ended September 30, 2014 and no other customer accounted for more than 10% of revenue Reported revenue primarily reflects sales related to the acquisition of the CTRM Business from Sanofi since May 30, 2014.

NOTE 14 — COMMITMENTS AND CONTINGENCIES

During 2013, the Company amended its operating lease with Domino’s Farms Office Park, LLC to extend the term of the lease for an additional five years, which began on May 1, 2013.  The Company now has a right to terminate on the third anniversary of the renewal, and has two five-year market value renewal options.  The Company’s leased facility includes a Class 100,000 modular manufacturing clean room, laboratories and office space.  The lease also provides the Company a right of first refusal on certain additional space.

In conjunction with the acquisition of the CTRM Business, the company assumed the leases for facilities in Cambridge, MA and Kastrup, Denmark.  The leases for the facilities in Cambridge and Kastrup are non-cancelable leases expiring at various dates through February 2017.

As of September 30, 2014, future minimum payments related to leases are as follows:

Rent expense for the three and nine months ended September 30, 2014 was approximately $1.4 million and $2.2 million, respectively, compared to $0.3 million and $0.9 million for those same periods in 2013.

As part of its acquisition of Verigen AG (Verigen), Genzyme Corporation, a subsidiary of Sanofi, agreed to make cash payments to Verigen upon the achievement of developmental milestones relating to regulatory and commercialization of MACI in the United States. In connection with the acquisition of the CTRM Business, the Company agreed that if it further developed MACI in the U.S., it would be obligated to pay these milestone payments, which the Company determined was remote. During the three months ended September 30, 2014, at the request of the Company, Sanofi entered into a settlement agreement with the former shareholders of Verigen whereby these shareholders agreed to discharge all obligations related to these MACI milestone payments in exchange for a one-time cash payment of €2.5 million (approximately $3.2 million) due within two months from the date when all parties sign the settlement agreement. The Company is a third-party beneficiary of the settlement agreement and, as agreed in connection with the acquisition of the CTRM Business, the Company was responsible to reimburse Sanofi for this €2.5 million payment.

At September 30, 2014, the $3.2 million was accrued and recorded as research and development expense in the Company’s financial statements in recognition of this agreement. The amount was subsequently paid on October 17, 2014. This agreement was reached in full settlement of any and all potential obligations to Verigen related to future MACI developmental milestones.

NOTE 15— LIQUIDITY:

As of September 30, the Company had $37.6 million of cash which is substantially higher than the $7.3 million of cash the Company had at June 30, 2014.  This increase is primarily due to the 2014 Offering which raised $37.5 million, net of the underwriting discount and offering costs. The Company believes this amount of cash will be sufficient to sustain operations for at least one year. In addition to the existing cash balance, the Company also has access to certain amounts of financing through an agreement with Lincoln Park Capital Fund, LLC (Lincoln Park).  The Company may direct Lincoln Park to purchase up to $15.0 million worth of shares of its common stock over a 30-month period generally in amounts up to 50,000 shares on certain business days under a Purchase Agreement (the Purchase Agreement) entered into with Lincoln Park on January 21, 2014 (the Lincoln Park Equity Line). As of September 30, 2014, the Company has issued to Lincoln Park 935,499 shares of common stock and raised $3.7 million. However, there are certain factors, such as volume of trading in the Company’s common stock, its stock price and the ability to terminate the agreement with notice, which limit the amount that can be raised in a short period of time through the Lincoln Park Equity Line. The extent to which the Company can rely on the Lincoln Park Equity Line as sources of funding will depend on a number of factors, including the prevailing market price of the common stock and the extent to which the Company is able to secure working capital from other sources. Additionally, during the nine months ended September 30, 2014, the Company raised net proceeds of $7.1 million utilizing its at the market sales agreement (ATM) with MLV & Co., LLC. The ATM, which as of September 30, 2014 had remaining capacity of approximately $7.8 million, allowed the Company to sell its common stock from time to time under a registration statement on

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Form S-3 filed in June 2011, pursuant to which the Company registered $100 million of its securities for public sale. The Form S-3 registration statement filed in June 2011 expired in July 2014.

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

Overview

We are a fully integrated, commercial-stage biopharmaceutical company dedicated to the identification, development and commercialization of innovative therapies that enable the body to repair and regenerate damaged tissues and organs to restore normal structure and function. Our product portfolio is comprised of patient-specific (autologous) cell therapies utilizing proprietary manufacturing processes and systems. We have marketed products as well as developmental stage product candidates and our goal is to become the leading cell therapy and regenerative medicine company by developing, manufacturing and marketing best-in-class therapies for patients with significant unmet medical needs.

Acquisition of Sanofi’s CTRM Business

On May 30, 2014 we completed the acquisition of certain assets of Sanofi, a French société anonyme (Sanofi), including all of the outstanding equity interests of Genzyme Biosurgery ApS (Genzyme Denmark), a wholly-owned subsidiary of Sanofi, and over 250 patents and patent applications of Sanofi and certain of its subsidiaries and assumed certain liabilities for purposes of acquiring the portion of the cell therapy and regenerative medicine business (the CTRM Business), which researches, develops, manufactures, markets and sells Carticel®, MACITM and Epicel® (the CTRM Transaction).

In consideration for the acquisition of the CTRM Business, we paid a total purchase price of approximately $6.5 million, as follows: (a) $4.0 million was paid in cash on the closing date of the CTRM Transaction, and (b) a $2.5 million promissory note was paid on July 30, 2014. In accordance with generally accepted accounting principles in the United States of America (U.S. GAAP), we recorded the assets and liabilities of the CTRM Business at fair value.  The net assets of the CTRM Business were preliminarily valued at $10.1 million, which is in excess of the $6.5 million purchase price, which resulted in a $3.6 million bargain purchase gain.  The primary driving factor for the bargain purchase gain was the structure of the CTRM Transaction.  As part of the CTRM Transaction, Sanofi funded Genzyme Denmark with $5.0 million in cash in order to fund the restructuring of the Denmark operations and close the facility.  Under U.S. GAAP, no restructuring actions were taken by Sanofi prior to our purchase of the CTRM Business, and accordingly, there were no restructuring related accruals in the opening balance sheet.  Additionally, there were no restrictions on the use of the cash in Genzyme Denmark.  We implemented our restructuring plans for Genzyme Denmark after the consummation of the CTRM Transaction, and accordingly, have recorded restructuring charges in our current period results of operations.  To date we have recorded restructuring charges of $3.1 million and expect to incur additional costs in the last quarter of 2014.  See Note 5, “Restructuring” for additional information.

Manufacturing

We acquired two cell-manufacturing facilities as part of the acquisition of the CTRM Business in Cambridge, Massachusetts and Copenhagen, Denmark. The Cambridge facility, which is approved by the U.S. Food and Drug Administration (FDA), is used for U.S. manufacturing and distribution of Carticel, Epicel manufacturing and also manufactured MACI for the SUMMIT study conducted for approval in Europe. The Copenhagen manufacturing facility, which was approved by the Danish Medicines Agency (DKMA), was responsible for MACI manufacturing and distribution in Europe. As part of the June 2014 restructuring, MACI manufacturing at the Copenhagen manufacturing facility has been discontinued. Going forward, any clinical and commercial production of MACI will occur at our Cambridge facility. We also operate a centralized cell manufacturing facility in Ann Arbor, Michigan. The facility supports the current ixCELL-DCM clinical trial being conducted in the United States and Canada and has sufficient capacity, with minor modifications, to supply our early commercialization requirements.

Product Portfolio

Our approved and marketed products were acquired through the CTRM Transaction and include three approved autologous cell therapy products, each of which are further described below:  Carticel (autologous cultured chondrocytes), a first-generation product for autologous chondrocyte implantation (ACI) currently marketed in the U.S., MACI (matrix-applied characterized autologous cultured chondrocytes), a third-generation ACI product, and Epicel (cultured epidermal autografts), a permanent skin replacement for full thickness burns greater than or equal to 30% of total body surface area.  Our product candidate portfolio also includes ixmyelocel-T, a patient-specific multicellular therapy currently in development for the treatment of advanced heart failure due to ischemic dilated cardiomyopathy (DCM).

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Carticel

Carticel, a first-generation ACI product for the treatment and repair of cartilage defects in the knee, is the first and only FDA-approved autologous cartilage repair product.  Carticel is indicated for the repair of symptomatic cartilage defects of the femoral condyle (medial, lateral or trochlea) caused by acute or repetitive trauma, in patients who have had an inadequate response to a prior arthroscopic or other surgical repair procedure such as debridement, microfracture, drilling/abrasion arthroplasty, or osteochondral allograft/autograft.  Carticel received a Biologics License Application (BLA) approval in 1997 and is currently marketed in the U.S.  It is generally used on patients with larger lesions (greater than 3 cm2).  In the year ended December 31, 2013, net revenues were $35.2 million for Carticel.

In the U.S., we focus net sales of Carticel on the sports-injury-targeted orthopedic physician target audience, which is very concentrated, with 60% of the current Carticel business originating from 25% of this audience, or approximately 110 physicians. We currently have a 20-person field force calling on these sports-injury targeted orthopedic physician audience.

Epicel

Epicel is a permanent skin replacement for full thickness burns greater than or equal to 30% of total body surface area (TBSA).  Epicel is the only FDA-approved autologous epidermal product available for large total surface area burns. Epicel was approved in the United States as a humanitarian use device (HUD) under a Humanitarian Device Exemption (HDE).  Devices eligible for an HDE are intended for diseases or conditions that occur in a maximum of 4,000 individuals annually in the United States. Currently, approximately 100 patients are treated with Epicel in the U.S. each year.  In the year ended December 31, 2013, net revenues were $7.1 million for Epicel.

Under the original HDE approval and pursuant to the Pediatric Medical Device Safety and Improvement Act of 2007 (PMDSIA), Epicel could not be sold for an amount that exceeds the costs of research and development, fabrication, and distribution and the number of patients treated could not exceed 4,000.  In 2012, the PMDSIA was modified so that under a HDE program, a manufacturer would be allowed to sell for a profit devices intended for a condition or disease that does not occur (or only rarely occurs) in pediatric patients, so long as it meets certain other specified conditions.  In addition, the modified PMDSIA does not cap the number of devices for which the manufacturer may obtain a profit per year at 4,000 devices, but rather assigns an “annual distribution number.” We are currently investigating the potential impact of this change on our ability to sell Epicel for a profit.  Prior to July 1, 2014, Epicel was being sold below standard costs and those costs allowed under the modified PMDSIA regulations.  As of July 1, 2014, we have increased the price of Epicel to reflect the full costs allowed under those regulations.

Up until July, 2014, we had one sales representative selling Epicel and two partially dedicated Medical Scientific Liaisons supporting Epicel inquiries. We have recently expanded the Epicel sales force to three representatives and will expect to increase the number of burn centers called upon.

MACI

MACI is a third-generation ACI product for the treatment of focal chondral cartilage defects in the knee.  MACI received marketing authorization in Europe in July 2013 by meeting the requirements of the Advanced Therapy and Medicinal Product (ATMP) guidelines.  MACI has been commercially available in the EU since 1998.  Sales of MACI have been temporarily discontinued as part of a restructuring of the business in August 2014, primarily due to low utilization and an unfavorable pricing environment.  We believe that MACI, which is a Phase 3 product candidate in the U.S., has significant revenue potential in the U.S., and we are planning to discuss approval requirements with the FDA. The timing and process to gain approval in the U.S. and a possible reintroduction in select EU countries have not yet been determined.

MACI was obtained via the acquisition by Genzyme Corporation, a subsidiary of Sanofi of Verigen AG (Verigen) in 2005.  As part of its acquisition of Verigen , Genzyme Corporation agreed to make cash payments to Verigen upon the achievement of developmental milestones relating to regulatory and commercialization of MACI in the United States. In connection with our acquisition of the CTRM Business, we agreed that if we further developed MACI in the U.S., we would be obligated to pay these milestone payments. During the three months ended September 30, 2014, Sanofi entered into an agreement with the former shareholders of Verigen whereby those shareholders agreed to discharge all obligations related to the MACI milestone payments in exchange for a one-time cash payment of €2.5 million (approximately $3.2 million)  due within two months from the date when all parties sign the settlement agreement.

We are a third-party beneficiary of the settlement agreement and, as we agreed in connection with the acquisition of the CTRM Business, we were responsible to reimburse Sanofi for this €2.5 million payment. At September 30, 2014, $3.2 million was accrued on

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our financial statements in recognition of this liability. The amount was paid on October 17, 2014. This agreement was reached in full settlement of any and all potential obligations to Verigen related to future MACI developmental milestones.

Ixmyelocel-T

Our preapproval stage portfolio also includes ixmyelocel-T, a unique patient-specific multicellular therapy derived from an adult patient’s own bone marrow which utilizes our proprietary, highly automated and scalable manufacturing system. Our proprietary cell manufacturing process significantly expands the mesenchymal stromal cells (MSCS) and M2-like anti-inflammatory macrophages in the patient’s bone marrow mononuclear cells while retaining many of the hematopoietic cells. These cell types are known to regulate the immune response and play a key role in tissue repair and regeneration by resolving pathologic inflammation, promoting angiogenesis, and remodeling ischemic tissue. The novelty and advantage of using ixmyelocel-T is the expansion of a unique combination of cell populations, including MSCS and M2-like macrophages, which secrete a distinct combination of angiogenic and regenerative factors, and possess the ability to remain anti-inflammatory in the face of inflammatory challenge.

Our lead clinical development program for ixmyelocel-T is focused on severe, chronic ischemic cardiovascular diseases. We are currently enrolling our Phase 2b ixCELL-DCM study, which is a randomized, double-blind, placebo-controlled clinical trial for patients with advanced heart failure due to ischemic DCM. Ixmyelocel-T has been granted a U.S. Orphan Drug designation by the FDA for the treatment of DCM. We also have an ongoing ixmyelocel-T clinical program for the treatment of craniofacial reconstruction and have conducted clinical studies for the treatment of critical limb ischemia.

The ongoing Phase 2b ixCELL-DCM clinical study is designed to treat 108 patients at approximately 35 sites in the U.S. and Canada. Patients will be followed for 12 months for the primary efficacy endpoint of MACE events, defined as all-cause deaths, all-cause hospitalizations, and unplanned outpatient or emergency department visits for IV treatment of acute worsening heart failure. Secondary endpoints include clinical, functional, structural, symptomatic, quality of life, and biomarker measures at 3, 6 and 9 months. Patients will be followed for an additional 12 months for safety. We expect to complete enrollment of the ixCELL-DCM study in 2014, and have top-line efficacy results approximately 12 months later.

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Results of Operations

NET LOSS

Our Net loss for the three and nine months ended September 30, 2014 totaled ($6.9 million) or ($0.82) per share and ($17.6 million) or ($2.90) per share. Results for the nine months ended September 30, 2014 include four months of operating results of the CTRM Business including restructuring charges of $3.1 million, expenses for the exited Denmark business of $0.8 million and a bargain purchase gain of approximately $3.6 million.

The following table summarizes the effect of the CTRM Transaction on our results of operations for the three and nine months ended September 30, 2014 (in thousands):