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ISCO > SEC Filings for ISCO > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for INTERNATIONAL STEM CELL CORP

Form 10-K for INTERNATIONAL STEM CELL CORP


17-Mar-2014

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

The Company has been in the development stage from inception through to the quarter ended September 30, 2013. During the quarter ended December 31, 2013, the Company exited the development stage based on a consistently, increasing revenue trend and more significant revenue totals generated from our two commercial businesses. The Company has generated product revenues from our two commercial businesses of $6.1 million and $4.6 million for the years ended December 31, 2013 and 2012, respectively. The Company currently has no revenue generated from its principal operations in therapeutic and clinical product development through 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 also offers the potential for the creation of immune-matched cells and tissues that are less likely to be rejected following transplantation. ISCO's collection of hpSCs, known as UniStemCell™, currently consists of fifteen stem cell lines. We have facilities and manufacturing protocols that comply with the requirements of Good Manufacturing Practice (GMP) standards as promulgated by the U.S. Code of Federal Regulations and enforced by the U.S. Food and Drug Administration ("FDA").


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Market Opportunity and Growth Strategy

Therapeutic Market - Clinical Applications of hpSCs for Disease Treatments. 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 ("PD"); 2) metabolic/liver diseases; and 3) corneal blindness. Using our proprietary technologies and know-how, we are creating neural stem 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. LSC's products are regulated as cosmetics. LSC's products are sold nationally and internationally through a branded website, through professional channels (including dermatologists, plastic surgeons, medical, day and resort spas,) and distributors. Domestically, we plan to increase distribution of our products by increasing brand awareness and resonance through advertising, sales promotion and public relations. Internationally, we are increasing distribution and sales through agreements with specialty distributors in both Latin America and Asia.

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, in order to address this significant market opportunity. 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.

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.

ISC California was incorporated in California in June 2006 for the purpose of restructuring the business of LCT, 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. LSC was formed in the State of California on June 5, 2009 and is a wholly-owned subsidiary of ISC California.

Results of Operations

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Revenues

Revenue for the year ended December 31, 2013, totaled $6.15 million, compared to $4.57 million in 2012. LCT contributed $2.94 million or 48% of total revenue in 2013, compared to $2.38 million or 52% of total revenue in 2012. The increase of $560,000 or 24% in LCT's revenue for 2013 was driven primarily by higher sales to OEM customers and international distributors. LSC's revenue of $3.21 million in 2013 accounted for 52% of total revenue, compared to $2.19 million or 48% of total revenue in 2012. In 2013, LSC's revenue increased by $1.02 million or 47% partially due to the one-time recognition of deferred revenue related to a change in estimate for our 30-day product return guarantee. We previously deferred all revenues from website sales until our 30-day product return guarantee had lapsed. In 2013, due to more reliable information available on actual historical returns for the two years ended December 31, 2013 and 2012, we were able to refine our estimated return rate. As a result of the change in estimate, we recognized previously deferred revenue of $277,000 and recorded an allowance for sales returns of $10,000, which is approximately 3% of one month's sales. The remainder of the revenue increase is due to our strategic efforts to expand and diversify sources of revenue across all channels. We saw the greatest sales growth in website sales and professional accounts.


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Cost of Sales

Cost of sales for the year ended December 31, 2013 was $1.64 million or 27% of revenue, compared to $1.27 million or 28% of revenue in 2012. The favorable reduction in cost of sales as a percentage of revenue in 2013 is primarily attributable to improvements in the manufacturing and supply chain management for LSC's products resulting in a 3% decrease in cost of sales partially offset by a 2% increase in cost of sales for LCT primarily due to an $82,000 increase in the reserve for inventory obsolescence and expiration.

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.

Research and Development ("R&D")

Research and development expenses were $3.56 million for the year ended December 31, 2013, compared to $3.60 million in 2012. R&D expense decreased approximately $39,000 or 1%. 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 release of preclinical rodent and non-human primate (NHP) PD study data in the first quarter of 2013. Building on the NHP PD pilot study, in May 2013 we initiated a large-scale pharmacology/toxicology primate study, which is intended to form a critical component of our Investigational New Drug (IND) application that we anticipate filing in late 2014 or early 2015. We anticipate increased R&D expenditures in 2014 and 2015 as a result of this large-scale primate study and the added costs associated with the filing of the IND application.

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, 2013 amounted to $2.46 million, reflecting an increase of approximately $392,000 or 20%, as compared to $2.07 million in 2012. The increase in spending was primarily driven by enhanced efforts in e-commerce marketing support, promotion and advertising expense of approximately $247,000, increased employee-related spending of $126,000 due to increased staff, increased website costs of $52,000, and incentive plan accrual of $81,000, logistics related costs of $86,000, increased trade show expenses of $49,000 with resulting higher travel and meals expense of $42,000, increased rent and utilities of $26,000, and higher commission expense of $17,000. The increase was partially offset by a reduction of $246,000 in consulting expenses, $71,000 in stock-based compensation and stock issued for consulting costs, and $16,000 in product testing costs.

The increase in commission expense was due to increased sales during 2013 over 2012, but was partially offset by a savings of $69,000 in 2013 from 2012 due to reductions in a marketing arrangement with a consultant who promotes, markets, and sells skin care products for LSC. Prior and up to June 30, 2012, we incurred a 20% marketing fee on net profits generated from the consultant's 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, 2013 and 2012, we recorded $80,000 and $149,000, respectively, as commission expense related to this agreement.

General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2013 were $6.03 million, reflecting a decrease of $1.41 million or 19%, compared to $7.44 million in 2012. The decrease is primarily attributable to a more streamlined operating cost structure including lower employee stock-based compensation of $684,000, reduced employee-related spending of $664,000 resulting from lower headcount, lower legal fees of $257,000, lower consulting expense of $253,000, lower corporate support expenses of $184,000, lower professional accounting fees of $132,000, a decrease in impairment of intangible assets totaling $138,000, lower board of director fees of $116,000, and lower travel and meals expense of $72,000. The decrease was partially offset by an increase in consulting fees for investor relations of $454,000, an incentive plan accrual of $230,000, an increase in stock-based compensation for services provided by consultants of $216,000, and higher temporary labor expense of $164,000.

Other Income/Expense

Other expense was $2.93 million for the year ended December 31, 2013, primarily due to recognizing $1.39 million for the fair value of warrant liability in excess of the investment proceeds received from our stock offering completed in July 2013, plus the associated financing costs of $738,000, plus the net loss from the subsequent revaluations of the warrant liability of $754,000 at each balance sheet date and upon warrant exercises. In 2012, we recorded other expense of $20,000.


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Liquidity and Capital Resources

As of December 31, 2013 and 2012, our cash and cash equivalents totaled $2.24 million and $654,000, respectively. At December 31, 2013 we had a working capital deficit of $2.40 million compared to working capital of $395,000 at December 31, 2012. The working capital deficit is due to the fair value of warrant liability of $4.93 million resulting from our S-1 July Registered Offering completed in July 2013.

Operating Cash Flows

Net cash used in operating activities was $5.64 million for the year ended December 31, 2013, compared to $6.69 million in 2012. The primary factor contributing to the variability in the reported cash flow amounts relates to the lower net loss after non-cash adjustments totaling $4.96 million in 2013, compared to $6.70 million in 2012.

Investing Cash Flows

Net cash used in investing activities was $896,000 for the year ended December 31, 2013, compared to $786,000 in 2012. Patent related spending approximated $729,000 during 2013. In addition, purchases of property and equipment totaling approximately $167,000 in 2013 consisted primarily of laboratory equipment, software, leasehold improvements and computer equipment.

Net cash used in investing activities was $786,000 for the year ended December 31, 2012. Purchases of property and equipment of $197,000 in 2012 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 $596,000 during 2012.

Financing Cash Flows

Net cash provided by financing activities was $8.12 million for the year ended December 31, 2013, compared to $6.79 million in 2012.

During the year ended December 31, 2013, we issued an additional 16.3 million shares of common stock in transactions that were not registered under the Securities Act of 1933. We issued a total of 1.2 million shares of common stock on various dates from January 1, 2013 through March 15, 2013 raising $264,000 from stock purchases by Aspire Capital, issued a total of 10.1 million shares of common stock on January 22, 2013 raising $2,025,000 from Dr. Andrey Semechkin, our Co-Chairman and Chief Executive Officer and Dr. Simon Craw, our Executive Vice President Business Development, and issued 5 million shares of common stock on March 12, 2013 raising $1,000,000 from a stock purchase by Dr. Andrey Semechkin and by other investors with long-standing relationships with and who closely follow the Company.

On July 24, 2013, we completed a financing transaction under a Form S-1 Registration Statement filed with the U.S. Securities and Exchange Commission raising approximately $2.4 million in net proceeds (the "S-1 July Registered Offering"). Also during the third and fourth quarters of 2013, we raised additional net proceeds of $2.4 million upon partial exercise of the Series A and B Warrants issued as part of the S-1 July Registered Offering.

In December 2013 we entered into a purchase agreement with Lincoln Park Capital Fund, LLC ("Lincoln Park"), pursuant to which Lincoln Park has agreed to purchase from us up to an aggregate of $10.25 million of our common stock (subject to certain limitations) from time to time through January 2017. Of the aggregate $10.25 million of our common stock that may be sold to Lincoln Park, on December 11, 2013, the trading day immediately preceding the date we first filed a registration statement for this transaction, we sold 1.67 million shares of our common stock to Lincoln Park for an aggregate purchase price of $250,000, which we refer to as the Initial Purchase. For further discussion of these transactions, see Note 6, Capital Stock, Common Stock transactions to our consolidated financial statements.

Net cash provided by financing activities was $6.79 million for the year ended December 31, 2012. 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.

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


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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 2014 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.

During the quarter ended December 31, 2013, we exited the development stage based on a consistently, increasing revenue trend and more significant revenue totals generated from our two commercial businesses. We have been in the development stage from inception through to the quarter ended September 30, 2013, and have accumulated losses from inception through the year ended December 31, 2013, and expect to incur additional losses in the near future. We currently have no revenue generated from our principal operations in therapeutic and clinical product development through research and development efforts. 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, 2013 our average burn rate was approximately $470,000 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 normal operating cash flow and that the timing of our capital expenditures will result in cash flow sufficient to sustain our operations through 2014. 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.

We do not currently have any obligations for milestone payments under any of our licensed patents other than the minimum license fee of $75,000 annually payable, 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 purchase agreement with Lincoln Park, we may sell from time to time up to an aggregate of $10.25 million of shares of common stock through January 2017. From January 15, 2014 through March 10, 2014, we sold a total of 3.8 million shares of common stock for an aggregate of approximately $817,000. For further discussion, see Note 12, Subsequent Events.

Off-Balance Sheet Arrangements

As of December 31, 2013, 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.


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

Previously we were a Development Stage Company

During the quarter ended December 31, 2013, we exited the development stage based on a consistently, increasing revenue trend and more significant revenue totals generated from our two commercial businesses. We have been in the development stage from inception through to the quarter ended September 30, 2013, and have accumulated losses from inception through the year ended December 31, 2013, and expect to incur additional losses in the near future. We currently have no revenue generated from our principal operations in therapeutic and clinical product development through 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.

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 . . .

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