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ISCO > SEC Filings for ISCO > Form 10-K on 26-Mar-2013All Recent SEC Filings

Show all filings for INTERNATIONAL STEM CELL CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K for INTERNATIONAL STEM CELL CORP


26-Mar-2013

Annual Report


ITEM 7. 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 consolidated financial statements and related notes and other financial information included elsewhere in this Annual Report on Form 10-K. 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. 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 present assessment by our management.

Business Overview

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

To date, the Company has generated limited incidental revenues to support its core therapeutic research and development efforts.

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 the potential for creation of immune-matched cells and tissues that are less likely to be rejected following transplantation into people across various ethnic groups. We have facilities and manufacturing protocols that comply with the requirements of the US Food and Drug Administration ("FDA") and other regulatory authorities.

Market Opportunity and Growth Strategy

Therapeutic Market - Clinical Applications of hpSCs for Disease Treatment. With respect to therapeutic research and product candidates, we focus 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; 2) metabolic/liver diseases; and 3) corneal blindness. Using our proprietary technologies and know-how, we are creating


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neuronal cells from hpSCs as a potential treatment of PD, liver cells from hpSCs that may be able to treat a variety of hepatic and metabolic liver diseases and corneal like structures from hpSCs that may be suitable for cornea transplantation and corneal healing in humans.

Cosmeceutical Market - Skin Care Products.Our wholly-owned subsidiary Lifeline Skin Care, Inc. ("LSC") develops, manufactures and markets cosmetic skin care products using an extract derived from our pluripotent stem cells. These proprietary products include a Defensive Day Serum, Recovery Night Serum and Firming Eye Complex, all of which include our patented stem cell extract and are regulated as cosmetics. LSC's products are regulated as cosmetics. Lifeline Skin Care products are sold nationally and internationally through a branded website; through professional channels (including dermatologists; plastic surgeons; medical, day and resort spas,) and distributors.

Biomedical Market - Primary Human Cell Research Products. Our wholly-owned subsidiary Lifeline Cell Technology, LLC ("LCT") develops, manufactures and commercializes over 130 human cell culture products, including frozen human "primary" cells and the reagents (called "media") needed to grow, maintain and differentiate the cells needed for human cell systems in the research market. 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. Each LCT cell product is quality tested for the expression of specific markers (to assure the cells are the correct type), proliferation rate, viability, morphology and absence of pathogens. Each cell system also contains associated donor information and all informed consent requirements are strictly followed. LCT's research products are marketed and sold by its internal sales force, OEM partners and LCT brand distributors in Europe and Asia.

While we have continued to expand our sales and marketing efforts in order to increase 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. 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.

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. LCT 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 professional spas.

Results of Operations

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Revenues

We are considered a development stage company, and as such our revenues are limited and not predictable. Revenue for the year ended December 31, 2012, totaled $4.57 million, compared to $4.53 million in 2011. LCT contributed $2.38 million or 52% of total revenue in 2012, compared to $2.08 million or 47% of total revenue in 2011. The increase of $296,000 or 14% in LCT's revenue for 2012 was driven primarily by higher sales to OEM customers and international distributors. LSC's revenue of $2.19 million in 2012 accounted for 48% of total revenue, compared to $2.45 million or 53% of total revenue in 2011. Revenue decreased by $261,000 or 11% due to higher discounts granted as part of our strategic efforts to expand and diversify sources of revenue.

Cost of Sales

Cost of sales for the year ended December 31, 2012 was $1.27 million or 28% of revenue, compared to $1.62 million or 36% of revenue in 2011. The favorable reduction in cost of sales as a percentage of revenue in 2012 is primarily attributable to improvements in the manufacturing and supply chain management pertaining to both LSC and 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. We aim to continue refining our manufacturing processes and supply chain management to further improve the cost of sales as a percentage of revenue for both LCT and LSC.


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Research and Development ("R&D")

Research and development expenses were $3.60 million for the year ended December 31, 2012, compared to $4.43 million in 2011. The decrease of approximately $835,000 or 19% in R&D expense is principally due to reductions in stock-based compensation expense of $434,000, consulting expenses of $368,000 associated with various research projects, laboratory supplies and laboratory facility-related expenses of $197,000, personnel-related spending of $137,000, and travel expenses of $25,000. The decrease was partially offset by higher stem cell line research and testing expenses of $323,000.

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 (NHP) PD study in the fourth quarter of 2012, the release of pre-clinical rodent and NHP 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.

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

Marketing expenses for the year ended December 31, 2012 amounted to $2.07 million, reflecting an increase of approximately $589,000 or 40%, as compared to $1.48 million in 2011. The rise in spending was primarily driven by increases in advertising and marketing expense of approximately $287,000, consulting expense of $244,000, logistics and selling-related expenses of $239,000, e-commerce website support expense of $112,000, employee-related spending of $64,000, and commission paid to various sales consultants of $43,000. The increase was partially offset by a reduction of $272,000 in sales commission paid to a consultant who promoted, marketed, and sold skin care products through various proprietary mailings and a reduction in employee stock-based compensation of $116,000.

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 month of December 2012, the commission rate was temporarily increased to 25% on net revenues derived from direct sales on qualifying volume of orders. For the years ended December 31, 2012 and 2011, we recorded $149,000 and $430,000, respectively, as marketing expenses related to this agreement.

General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2012 were $7.44 million, reflecting a decrease of $916,000 or 11%, compared to $8.36 million in 2011. The decrease was largely attributable to a more streamlined operating cost structure including reductions in stock-based compensation expense of $873,000, corporate support expenses of $343,000, personnel-related spending resulting from lower headcount of $266,000, and consulting expense of $123,000. The decrease was partially offset by an increase in legal fees of $343,000 pertaining to capital raising and corporate matters, an increase in impairment of intangible assets totaling $187,000, an increase in professional accounting fees and corporate governance expenses of $92,000, and an increase in rent expense of $71,000.

Other Income/Expense

Other expense was $20,000 for the year ended December 31, 2012. In 2011, we recorded other income of $2.18 million reflecting the substantial decrease in the fair value of our warrant liabilities which expired on February 14, 2012.

Liquidity and Capital Resources

As of December 31, 2012, our cash and cash equivalents totaled $654,000, compared to $1.34 million as of December 31, 2011. Working capital at December 31, 2012, totaled $395,000, compared to $905,000 at December 31, 2011.

Operating Cash Flows

Net cash used in operating activities was $6.69 million for the year ended December 31, 2012, compared to $6.96 million in 2011. The primary factor contributing to the variability in the reported cash flow amounts relates to the lower net loss after non-cash adjustments totaling $6.70 million in 2012, compared to $7.00 million in 2011.


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Investing Cash Flows

Net cash used in investing activities was $786,000 for the year ended December 31, 2012, compared to $941,000 in 2011. Patent related spending approximated $596,000 during 2012. In addition, purchases of property and equipment totaling approximately $197,000 in 2012 consisted primarily of laboratory equipment, software, leasehold improvements and computer equipment.

Net cash used in investing activities was $941,000 for the year ended December 31, 2011. Purchases of property and equipment of $565,000 in 2011 consisted primarily of laboratory equipment, furniture, computer equipment and leasehold improvements related to new corporate offices. In addition, we made payments for patent licenses of $376,000 during 2011.

Financing Cash Flows

Net cash provided by financing activities was $6.79 million for the year ended December 31, 2012, compared to $3.46 million in 2011. We received approximately $4.94 million, net of stock issuance costs, from the issuance of five million shares of Series G Preferred Stock in 2012. For further discussion, see Note 6, Capital Stock, Series G Preferred Stock. In addition, we raised $2.09 million from the issuance of 5,000,000 shares of common stock to Aspire Capital Group and paid dividends of $237,000 to our preferred stockholders.

Net cash provided by financing activities was $3.46 million for the year ended December 31, 2011. We issued 4.0 million shares of common stock to Aspire Capital Group for approximately $3.36 million. In addition, we raised $532,000 from warrants and options exercised and paid dividends of $430,000 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 evaluating various financing sources and options to raise working capital to help fund our current research and development programs and 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 2013 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. For the year ended December 31, 2012 our average burn rate was approximately $580,000 per month, excluding capital expenditures and patent costs averaging $70,000 per month. There can be no assurance that we will be successful in maintaining our 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


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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 purposes, 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 minimum royalty payment of $75,000 due in two installments per year to Advanced Cell Technology pursuant to the amended UMass IP license agreement. No licenses are terminable at will by the licensor. For further discussion of our patents, see Note 4 to our 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 December 31, 2012, we sold a total of 9,333,333 shares of common stock to Aspire Capital for an aggregate of $5,942,000. In addition, in February 2013, we sold an additional 1,200,000 shares to Aspire Capital for an aggregate of $264,000.

In January 2013, to obtain funding for working capital purposes, we entered into a Securities Purchase Agreement (the "January 2013 Purchase Agreement") and raised $2,025,000 through the sale of shares of our common stock and warrants to purchase additional shares of common stock. In March 2013, to obtain further funding for working capital purposes, we entered into another Securities Purchase Agreement (the "March 2013 Purchase Agreement") and raised $1,000,000 through the sale of shares of our common stock and warrants to purchase additional shares of common stock. For further discussion, see Note 11, Subsequent Events.

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 December 31, 2012, we did not have any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an on-going basis, we evaluate our estimates and assumptions, including those related to revenue recognition, allowances for accounts receivable, inventories, intangible assets, warrant liabilities, stock-based compensation and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.

We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.

Development Stage Company

We are a development stage entity with no revenue generated from our principal operations in therapeutic research and development efforts. To date, we have generated limited and unpredictable incidental revenues to support our core therapeutic research and development efforts.

Inventories

We account for inventory using the first-in, first-out (FIFO) method for our Lifeline Skin Care products, Lifeline Cell Technology cell culture media and reagents, and specific identification method for our Lifeline Cell Technology products. We state our inventory balances at the lower of cost or market. Lab supplies used in the research and development process are expensed as consumed. Inventory is reviewed periodically for product expiration and obsolescence and is adjusted accordingly.


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Property and Equipment

We record property and equipment at cost. The provision for depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets, generally over five years. The costs of major remodeling and leasehold improvements are capitalized and depreciated over the shorter of the remaining term of the lease or the life of the asset.

Intangible Assets

Intangible assets consist of acquired research and development rights used in research and development, and capitalized legal fees related to the acquisition, filing, maintenance, and defense of patents. Patents and patent licenses are recorded at cost and are amortized on a straight-line basis over the shorter of the lives of the underlying patents or the useful life of the intangible asset, generally 15 years. Intangible asset amortization expenses are included in research and development expenses.

Long-Lived Asset Impairment

We review long-lived assets for impairment when events or changes in business conditions indicate that their carrying value may not be recovered, at least annually. We consider assets to be impaired and write them down to fair value if expected associated undiscounted cash flows are less than the carrying amounts. Fair value is the present value of the associated cash flows. Due to the numerous variables associated with our judgments and assumptions relating to the carrying value of our intangible assets and the effects of changes in circumstances affecting these valuations, both the precision and reliability of the resulting estimates are subject to uncertainty. As additional information becomes known, we may change our estimate, in which case the likelihood of a material change in our reported results would increase.

Revenue Recognition

We recognize revenue when all four of the following criteria are met:
(i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectability is reasonably assured. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenues recognized for any reporting period could be adversely impacted.

Cost of Sales

Cost of sales consists primarily of salaries and benefits associated with employee efforts expended directly on the production of the Company's products and include related direct materials, general laboratory supplies and allocation of overhead. Certain of the agreements under which the Company has licensed technology will require the payment of royalties based on the sale of its future products. Such royalties will be recorded as a component of cost of sales. Additionally, the amortization of license fees or milestone payments related to developed technologies used in the Company's products will be classified as a component of cost of sales to the extent such payments become due in the future. Cost of sales included salaries and benefits related to manufacturing, third party manufacturing costs, raw materials, general laboratory supplies and an allocation of overhead.

Research and Development Costs

Research and development costs, which are expensed as incurred, are primarily comprised of salaries and benefits associated with research and development personnel, overhead and occupancy, contract services, and amortization of license costs for technology used in research and development with alternative future uses.

Registration Payment Arrangements

We are required to separately recognize and measure registration payment arrangements, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement. Such payments include penalties for failure to effect a registration of securities.

Stock-Based Compensation

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