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ISCO > SEC Filings for ISCO > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for INTERNATIONAL STEM CELL CORP

Form 10-Q for INTERNATIONAL STEM CELL CORP


8-Nov-2012

Quarterly Report


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

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes and other financial information included elsewhere herein. This information should also be read in conjunction with our audited historical consolidated financial statements which are included in our Form 10-K for the fiscal year ended December 31, 2011. The discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, expectations and intentions. Our actual results may differ significantly from management's expectations, as a result of the risks discussed later in this report. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best assessment by our management.

Business Overview

We are a development-stage biotechnology company focused on therapeutic, biomedical and cosmeceutical product development with multiple long-term therapeutic opportunities and two revenue-generating businesses offering potential for increased future revenue.

Our products are based on multi-decade experience with human cell culture and a proprietary type of pluripotent stem cells, "human parthenogenetic stem cells" ("hpSCs"). Our hpSCs are comparable to human embryonic stem cells ("hESCs") in that they have the potential to be differentiated into many different cells in the human body. However, the derivation of hpSCs does not require the use of fertilized eggs or the destruction of viable human embryos, and they offer potential for creation of immune-matched cells and tissues that are less likely to be rejected following transplantation into people across various ethnic groups. ISCO has facilities and manufacturing protocols that comply with the requirements of the US Food and Drug Administration ("FDA") and other regulatory authorities.

With respect to therapeutic research, ISCO focuses on applications where cell and tissue therapy is already proven but where there is an insufficient supply of safe and functional cells or tissue. We believe that the most promising potential clinical applications of our technology are: 1) Parkinson's disease, a chronic neurodegenerative disease; 2) various inherited/metabolic liver diseases; and 3) corneal blindness.

ISCO's wholly-owned subsidiary Lifeline Skin Care, Inc. ("LSC") develops, manufactures and markets cosmetic skin care products using an extract derived from our human stem cell technologies. These products are regulated as cosmetics. Furthermore, marketing and sales are conducted direct to the consumer via the internet as well as channels such as dermatology clinics and spas, thus providing important revenue to help support our internal development of therapeutic products. LSC currently sells its products nationally and internationally through a branded website and select distributors.

ISCO's wholly-owned subsidiary Lifeline Cell Technology, LLC ("LCT") develops, manufactures and commercializes human cells and the reagents needed to culture and study human cells. LCT's scientists have used a technology called basal medium optimization to systematically produce optimized products designed to culture specific human cell types and to elicit specific cellular behaviors. These techniques also produce products that do not contain non-human animal proteins, a feature desirable to the research and therapeutic markets. LCT distinguishes itself in the industry by having in place scientific and manufacturing staff with the experience and knowledge to set up systems and facilities to produce a source of consistent, standardized, non-human animal protein free cell products, some of which are suitable for FDA approval. LCT also provides important funds to help support our internal development of therapeutic products. LCT's products are marketed and sold by its internal sales force, OEM partners and LCT brand distributors in Europe and Asia.

While we continued to expand our sales and marketing efforts to optimize revenue, to date we have generated limited revenue to support our core therapeutic research and development efforts.

We were originally incorporated in Delaware on June 7, 2005 as BTHC III, Inc. to effect the reincorporation of BTHC III, LLC, a Texas limited liability company, mandated by a plan of reorganization. Pursuant to the plan of reorganization, an aggregate of 500,000 shares of our common stock were issued to holders of administrative and tax claims and unsecured debt, of which 350,000 shares were issued to Halter Financial Group. The plan of reorganization required BTHC III, Inc. to consummate a merger or acquisition prior to June 20, 2007. Until the Share Exchange Agreement described below, BTHC III, Inc. conducted no operations. In October 2006, BTHC III, Inc. affected a 4.42-for-one stock split with respect to the outstanding shares of common stock.

On December 28, 2006, pursuant to a Share Exchange Agreement, BTHC III, Inc. issued 33,156,502 shares of common stock, representing approximately 93.7% of the common stock outstanding immediately after the transaction, to the shareholders of International Stem Cell Corporation, a California corporation ("ISC California"), in exchange for all outstanding stock of ISC California. This transaction is being accounted for as a "reverse merger" for accounting purposes. Consequently, the assets and liabilities and the historical operations that are reflected in our financial statements are those of ISC California.


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ISC California was incorporated in California in June 2006 for the purpose of restructuring the business of Lifeline Cell Technology, LLC, which was organized in California in August 2001. As a result of the restructuring, LCT became wholly-owned by ISC California, which in turn is wholly-owned by us. Lifeline Cell Technology is responsible for developing, manufacturing and distributing all of its products.

Lifeline Skin Care, Inc. was formed in the State of California on June 5, 2009 and is a wholly-owned subsidiary of ISC California. LSC creates cosmetic skin care products using an ingredient derived from our human cell technologies. LSC currently sells its products globally through a branded website, domestic and international distributors, physicians and spas.

Results of Operations

Revenues

We are considered a development stage company, and as such our revenues are limited and not predictable. Revenue for the three months ended September 30, 2012 totaled $1.19 million, compared to $842,000 for the three months ended September 30, 2011, representing an increase of $348,000 or 41%. The increase was driven by higher sales generated from both LSC and LCT. Product revenues for the nine months ended September 30, 2012 were $3.32 million compared to $3.47 million for the corresponding period in 2011, representing a decrease of $150,000 or 4%. The decrease is due principally to fewer sales generated from LSC, partially offset by LCT's higher sales generated primarily from OEM customers and international distributors.

LSC accounted for $525,000 or approximately 44% of total revenue during the three months ended September 30, 2012, compared to $359,000 or 43% of total revenue during the same period in 2011. For the nine months ended September 30, 2012, LSC generated $1.59 million or 48% of total revenue, compared to $2.02 million or 58% of total revenue in the corresponding period in 2011. LCT contributed $663,000 or approximately 56% of total revenue in the three months ended September 30, 2012, compared to $484,000 or 57% of total revenue for the same period in 2011. For the nine months ended September 30, 2012, LCT generated $1.73 million or 52% of total revenue, compared to $1.45 million or 42% of total revenue for same period in 2011.

Cost of sales

Cost of sales for the three months ended September 30, 2012 was $320,000 or 27% of revenue, compared to $361,000 or 43% of revenue for the corresponding period in 2011. The favorable reduction in cost of sales as a percentage of revenue is attributable to increased efficiency and effectiveness in the manufacturing and management of supply chain related to both LSC and LCT businesses. In addition, lower overhead costs and more effective inventory management by LCT contributed to the reduction in cost of sales as a percentage of revenue.

Cost of sales for the nine months ended September 30, 2012 was $957,000 or 29% of revenue, compared to $1.15 million or 33% of revenue for the same period in 2011. Increased efficiency and effectiveness in the manufacturing and management of supply chain and inventory by both LCT and LSC contributed to a favorable reduction in the cost of sales a percentage of revenue. The favorable reduction was partially offset by a shift in sales mix from higher margin products related to LSC to sales of lower margin products related to LCT.

Cost of sales reflects direct costs including salaries and benefits related to manufacturing, third party manufacturing costs, materials, general laboratory supplies and an allocation of overhead. As we continue to refine our manufacturing processes on our media and cell type products, and our sales volume continues to increase for these products, we anticipate that our cost of sales as a percentage of product sales will decrease.

Research and Development ("R&D")

Research and development expenses were $900,000 for the three months ended September 30, 2012, compared to $1.13 million for the same period in 2011. The decrease of $230,000 is due primarily to lower stock-based compensation expense of $205,000, lower personnel-related spending of $87,000, lower consulting expenses of $84,000 associated with various research projects, partially offset by higher stem cell line research and testing expenses of $90,000 and higher laboratory materials expense of $73,000.

Research and development expenses were $2.70 million for the nine months ended September 30, 2012, compared to $3.26 million for the same period in 2011. The decrease of $560,000 is due primarily to lower stock-based compensation expense of $360,000, lower consulting expenses of $270,000 associated with various research projects, lower personnel-related spending of $74,000, lower laboratory-related expenses of $52,000, and reduced travel expenses of $23,000, partially offset by higher stem cell line research and testing expenses of $233,000 and higher laboratory materials expense of $28,000.

R&D is focused on the development of treatments for Parkinson's disease (PD), metabolic liver diseases (such as Crigler-Najjar syndrome, (CNS) and Alpha 1-antitrypsin deficiency (A1AD)), diseases of the eye and the creation of new cGMP grade human parthenogenetic stem cell lines. These projects are long-term investments that involve developing both new stem cell lines and new differentiation techniques that can provide higher purity populations of functional cells. We do not expect these projects to provide near-term revenue, although we have published milestones including the initiation of a non-human primate PD study in the fourth quarter of 2012, the release of rodent PD study data in the first quarter of 2013 and the initiation of a Gunn rat rodent study to look at CNS, a rare but sometimes fatal inherited liver disease.


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Research and development expenses are expensed as they are incurred, and are accounted for on a project by project basis; however much of our research has potential applicability to each of our projects.

Selling and Marketing Expense

Selling and marketing expenses for the three months ended September 30, 2012 were $477,000, reflecting an increase of $112,000 or 31%, as compared to $365,000 for the same period in 2011. The increase was primarily driven by higher advertising expense of $89,000 reflecting augmented efforts to promote and build brand awareness for our skin care products, higher logistic and selling-related expenses of $57,000, higher consulting expense of $35,000, higher commission paid to various sales consultants of $25,000, and higher e-commerce website support expense of $19,000. The increase was partially offset by reductions of $37,000 in stock-based consulting expense, $33,000 in employee stock-based compensation, $23,000 in sales commission primarily paid to a consultant who promoted, marketed, and sold skin care products through various proprietary mailings and $20,000 in employee-related expenses.

For the nine months ended September 30, 2012, marketing expenses amounted to $1.52 million, reflecting an increase of $490,000 or 48%, as compared to $1.03 million for the corresponding period in 2011. The increase was primarily driven by higher advertising spending of approximately $177,000, higher logistic and selling-related expenses of $169,000, higher consulting expense of $165,000, higher e-commerce website support expense of $126,000, higher employee-related spending of $82,000 resulting from increased headcount in the sales and marketing of the skin care products, higher commission paid to various sales consultants of $62,000, and higher stock-based consulting expense of $36,000. The increase was partially offset by a reduction of $244,000 in sales commission primarily paid to a consultant who promoted, marketed, and sold skin care products through various proprietary mailings and lower employee stock-based compensation of $87,000.

Regarding the marketing arrangement with the abovementioned consultant who promoted, marketed, and sold skin care products, prior and up to June 30, 2011, we incurred a 40% marketing fee on net profits generated from these proprietary mailings. In June 30, 2011, we renegotiated and formalized this arrangement in a marketing agreement, which specifies a reduced 20% marketing fee on net revenues generated from these proprietary mailings. Subsequently in July 2012, we renegotiated the commission structure to reflect slightly lower rates, 18% on net revenues derived from direct sales and 9% on net revenues derived from referral sales. For the three and nine months ended September 30, 2012, we recorded $33,000 and $119,000, and for the same periods in 2011, we recorded $56,000 and $363,000, respectively, as marketing expenses related to this agreement.

We aim to strengthen our brand by refining our sales and marketing strategies, expanding our sales channels and improving the efficiency and effectiveness of our operations to optimize sales

General and Administrative Expenses

General and administrative expenses for the three months ended September 30, 2012 were $1.57 million, reflecting a decrease of $540,000 or 26%, compared to $2.11 million for the same period in 2011. The decrease, reflecting a more streamlined operating structure, resulted largely from reduced employee-related spending resulting from lower headcount of $199,000, lower employee stock-based compensation of $194,000, lower corporate support and administrative expenses of $103,000, lower consulting fees of $34,000, and lower professional accounting fees of $31,000. The decrease was partially offset by higher rent expense of $34,000, and legal fees of $14,000 relating to our corporate activities.

General and administrative expenses for the nine months ended September 30, 2012 were $5.36 million, reflecting a decrease of $1.12 million or 17%, compared to $6.48 million for the same period in 2011. The decrease was largely attributable to lower employee stock-based compensation totaling $542,000, the absence of stock-based compensation for services provided by a consultant amounting to $303,000, reduced employee-related spending resulting from lower headcount of $211,000, and lower corporate support expenses of $172,000. The decrease was partially offset by an increase in legal fees of $98,000 relating to our corporate expenses, higher rent expense of $69,000, and higher professional accounting fees related to Sarbanes-Oxley compliance efforts of $13,000.

Other Income/Expense

Other expense for the three months ended September 30, 2012 was $1,000, compared to other income of $557,000 for the same period in the prior year, primarily reflecting the substantial decrease in the fair value of our warrant liabilities which expired on February 14, 2012. Other expense for the nine months ended September 30, 2012 totaled $10,000, compared to other income of $1.90 million for the same period in the prior year. The significant variance is the result of a substantial decrease in the fair value of our warrant liabilities which expired on February 14, 2012.


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Liquidity and Capital Resources

As of September 30, 2012, our cash and cash equivalents totaled $2.38 million, compared to $1.34 million as of December 31, 2011. As of September 30, 2012, we had working capital of $2.24 million, compared to $905,000 as of December 31, 2011.

Operating Cash Flows

Net cash used in operating activities was $5.12 million for the nine months ended September 30, 2012, compared to $5.53 million for the corresponding period in 2011. The primary factors contributing to the variability in the reported cash flow amounts relate to lower inventory, reduced deferred revenue resulting from lower sales generated from skin care products, and timing of operating expenses and customer payments and billings.

Investing Cash Flows

Net cash used in investing activities was $630,000 for the nine months ended September 30, 2012, compared to $809,000 in the same period in 2011. Investing activities in the nine months ended September 30, 2012 consisted of legal fees related to intangible assets and computer equipment, lab equipment, software and leasehold improvements related to our manufacturing facilities.

Financing Cash Flows

Net cash provided by financing activities was $6.79 million for the nine months ended September 30, 2012, compared to $3.15 million in the same period in 2011. The net proceeds of $6.79 million received in 2012 were primarily attributable to the issuance of five million shares of Series G Preferred Stock for approximately $4.94 million, which is net of stock issuance costs. For further discussion, see Note 6, Capital Stock, Series G Preferred Stock. In addition, during the nine months ended September 30, 2012, we raised $2.09 million from the issuance of 5,000,000 shares of common stock to Aspire Capital Group. We paid dividends of $237,000 to our preferred stockholders.

On October 12, 2012, the Company and the holders of all of the outstanding shares of Series D and Series G Preferred Stock entered into a Waiver Agreement (the "Waiver Agreement") pursuant to which such holders irrevocably waived their right to receive any and all accrued but unpaid dividends and interest thereon on or after September 30, 2012 on the Series D and Series G Preferred Stock. Accordingly, we reversed all previously accreted and recorded dividends related to Series G Preferred Stock totaling $93,000. Under the Waiver Agreement, the holders of Series D and Series G Preferred Stock are restricted from transferring any shares of Series D or Series G Preferred Stock unless the transferee agrees to be bound by the Waiver Agreement.

Management is currently reviewing different financing sources and options to raise working capital to help fund our current operations. We will need to obtain significant additional capital from sources including equity and/or debt financings, license arrangements, grants and/or collaborative research arrangements to sustain our operations and develop products. Thereafter, we will need to raise additional working capital. Unless we obtain additional financing, we do not have sufficient cash on hand to operate for 12 months from the consolidated balance sheet date. The timing and degree of any future capital requirements will depend on many factors, including:

the accuracy of the assumptions underlying our estimates for capital needs in 2012 and beyond;

the extent that revenues from sales of LSC and LCT products cover the related costs and provide capital;

scientific progress in our research and development programs;

the magnitude and scope of our research and development programs and our ability to establish, enforce and maintain strategic arrangements for research, development, clinical testing, manufacturing and marketing;

our progress with preclinical development and clinical trials;

the time and costs involved in obtaining regulatory approvals;

the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims; and

the number and type of product candidates that we pursue.

Additional financing through strategic collaborations, public or private equity financings or other financing sources may not be available on acceptable terms, or at all. Additional equity financing could result in significant dilution to our stockholders. Additional debt financing may be expensive and require us to pledge all or a substantial portion of our assets. Further, if additional funds are obtained through arrangements with collaborative partners, these arrangements may require us to relinquish rights to some of our technologies, product candidates or products that we would otherwise seek to develop and commercialize on our own. If sufficient capital is not available, we may be required to delay, reduce the scope of or eliminate one or more of our product initiatives.

We continue to operate as a development stage entity and as such have accumulated losses from inception and expect to incur additional losses in the near future. We need to raise additional working capital. The timing and degree of any future capital requirements will depend on many factors. Currently our burn rate is approximately $600,000 per month, excluding capital expenditures and patent costs averaging $75,000 per month. There can be no assurance that we will be successful in maintaining our


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normal operating cash flow and that the timing of our capital expenditures will result in cash flow sufficient to sustain our operations through 2013. Based on the above, there is substantial doubt about our ability to continue as a going concern. The consolidated financial statements were prepared assuming that we will continue to operate as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. Management's plans in regard to these matters are focused on managing our cash flow, the proper timing of our capital expenditures, and raising additional capital or financing in the future. In March 2012, to obtain funding for working capital purpose, the Company sold 5,000,000 shares of Series G Preferred Stock raising $5 million, and during the first quarter of 2012 sold 5,000,000 shares of common stock to Aspire Capital Fund, LLC, for $2.1 million.

We do not currently have any obligations for milestone payments under any of our licensed patents other than the annual payments of $150,000 due each May to Advanced Cell Technology, plus payments that are specifically related to sales and are therefore unpredictable as to timing and amount. Royalties on sales range of 3% to 12%, and milestone payments do not begin until our first therapeutic product is launched. No licenses are terminable at will by the licensor. For further discussion of our patents, see Note 4 to our condensed consolidated financial statements.

Under our Common Stock Purchase Agreement with Aspire Capital Fund, LLC ("Aspire Capital"), we may sell from time to time up to an aggregate of $25.0 million of shares of common stock through approximately January 2014. From commencement through September 30, 2012, we sold a total of 9,333,333 shares of common stock to Aspire Capital for an aggregate of $5,942,000.

We have filed a registration statement with the SEC that, following effectiveness, would allow us to raise up to $15 million from the sale of common stock and warrants. However, this is a "best efforts" offering and we cannot predict the timing or amount of any funds that we may actually receive.

Off-Balance Sheet Arrangements

As of September 30, 2012, we did not have any off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not required.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Based on that evaluation, our chief executive officer and our chief financial officer have concluded that, at September 30, 2012, our disclosure controls and procedures were effective.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in internal control over financial reporting

Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we carried out an evaluation of any potential changes in our internal control over financial reporting during the fiscal quarter covered by this quarterly report on Form 10-Q.

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2012 that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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