International Stem Cell CORP 10-K

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 audited consolidated financial statements and accompanying notes to those consolidated financial statements and other financial information included elsewhere in this Annual Report on Form 10-K. The discussion contains forward-looking statements, such as our plans, expectations and intentions (including those related to clinical trials and business and expense trends), that are based upon current expectations and that involve risks and uncertainties. Our actual results may differ significantly from management’s expectations. The factors that could affect these forward-looking statements are in Part I, Item 1A. Risk Factors of this report. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any expectations expressed 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 have generated aggregate product revenues from our two commercial businesses of $7.8 million and $8.2 million for the years ended December 31, 2023 and 2022, respectively. We currently have no revenue generated from our principal operations in therapeutic and clinical product development. 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. Our collection of hpSCs, known as UniStemCell™, currently consists of 15 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 United States Food and Drug Administration (“FDA”). Market Opportunity and Growth Strategy Therapeutic Market – Clinical Applications of hpSCs for Disease Treatments We believe that the most promising potential clinical applications of our technology are Parkinson’s disease ("PD”), traumatic brain injury ("TBI”), and stroke. Using our proprietary technologies and know-how, we are creating neural stem cells from hpSCs as a potential treatment of PD, TBI, and stroke. PD : Our most advanced project is the neural stem cell program for the treatment of Parkinson’s disease. In 2013, we published in Nature Scientific Reports the basis for our patent on a new method of manufacturing neural stem cells, which is used to produce the clinical-grade cells necessary for future clinical studies and commercialization. In 2014, we completed the majority of the preclinical research, establishing the safety profile of NSC in various animal species, including non-human primates. In June 2016, we published the results of a 12-month pre-clinical non-human primate study, which demonstrated the safety, efficacy and mechanism of action of the ISC- hpNSC®. In 2017, we dosed four patients in our Phase I trial of ISC-hpNSC®, human parthenogenetic stem cell-derived neural stem cells for the treatment of Parkinson’s disease. We reported 12-month results from the first cohort and 6-month interim results of the second cohort at the Society for Neuroscience annual meeting (Neuroscience 2018) in November 2018. In April 2019, we announced the completion of subject enrollment, with the 12th subject receiving a transplantation of the highest dose of cells. There have been no safety signals or serious adverse effects seen to date as related to the transplanted ISC-hpNSC® cells. We announced a successful completion of the dose escalating phase 1 clinical trial in June 2021. In terms of preliminary efficacy, where scores are compared against baseline before transplantation, we observed a potential dose-dependent response with an apparent peak effectiveness at our middle dose. The % OFF-Time, which is the time during the day when levodopa medication is not performing optimally and PD symptoms return, decreased an average 47% from the baseline at 12 months post transplantation in cohort 2. This trend continued through 24 months where the % OFF-Time in the second cohort dropped by 55% from the initial reading. The same was true for % ON-Time without dyskinesia, which is the time during the day when levodopa medication is performing optimally without dyskinesia. The % ON-Time increased an average of 42% above the initial evaluation at 12 months post-transplantation in the second cohort. Stroke : In August 2014, we announced the launch of a stroke program, evaluating the use of ISC-hpNSC® transplantation for the treatment of ischemic stroke using a rodent model of the disease. The Company has a considerable amount of safety data on ISC-hpNSC® from the Parkinson’s disease program and, as there is evidence that transplantation of ISC-hpNSC® may improve patient 29 outcomes as an adjunctive therapeutic strategy in stroke, having a second program that can use this safety dataset is therefore a logical extension. In 2015, the Company together with Tulane University demonstrated that NSC can significantly reduce neurological dysfunction after a stroke in animal models. TBI : In October 2016, we announced the results of the pre-clinical rodent study, evaluating the use of ISC-hpNSC® transplantation for the treatment of TBI. The study was conducted at the University of South Florida Morsani College of Medicine. We demonstrated that animals receiving injections of ISC-hpNSC® displayed the highest levels of improvements in cognitive performance and motor coordination compared to vehicle control treated animals. In February 2019, we published the results of the pre-clinical study in Theranostics, a prestigious peer-reviewed medical journal. The publication titled, "Human parthenogenetic neural stem cell grafts promote multiple regenerative processes in a traumatic brain injury model,” demonstrated that the clinical-grade neural stem cells used in our Parkinson’s disease clinical trial, ISC-hpNSC®, significantly improved TBI-associated motor, neurological, and cognitive deficits without any safety issues. Anti-Aging Cosmetic Market – Skin Care Products Our wholly owned subsidiary Lifeline Skin Care, Inc. ("LSC”) develops, manufactures, and sells anti-aging skin care products based on two core technologies: encapsulated extract derived from hpSC and specially selected targeted small molecules. LSC’s products include: • ProPlus Advanced Defense Complex • ProPlus Advanced Recovery Complex • ProPlus Eye Firming Complex • ProPlus Neck Firming Complex • ProPlus Advanced Aqueous Treatment • ProPlus Collagen Booster (Advanced Molecular Serum) • ProPlus Elastin Booster • ProPlus Brightening Toner LSC’s products are regulated as cosmetics. LSC’s products are sold domestically through a branded website, Amazon, and ecommerce partners. Biomedical Market – Primary Human Cell Research Products Our wholly owned subsidiary LCT develops, manufactures and commercializes approximately 200 human cell culture products, including frozen human “primary” cells and the reagents (called “media”) needed to grow, maintain and differentiate the cells. LCT’s scientists have used a standardized, methodical, scientific approach to basal medium optimization to systematically produce optimized products designed to culture specific human cell types and to elicit specific cellular behaviors. These techniques can also be used to 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. 30 Results of Operations Comparison of the Years Ended December 31, 2023 and 2022 The following table summarizes our results of operations for the years ended December 31, 2023 and 2022, together with the dollar and percent change in those items (in thousands): Year Ended December 31, 2023 2022 $ Change % Change Product sales $ 7,789 $ 8,180 $ (391 ) -5 % Cost of sales 3,181 3,269 (88 ) -3 % Profit margin 4,608 4,911 (303 ) -6 % As a % of revenues 59 % 60 % General and administrative 3,514 3,357 157 5 % Selling and marketing 1,246 1,245 1 0 % Research and development 511 492 19 4 % Other income (expense), net 532 (148 ) 680 * Net loss $ (131 ) $ (331 ) $ 200 -60 % As a % of revenues -2 % -4 % * denotes a change in excess of 100% Product Sales Product sales revenue for the year ended December 31, 2023 was $7,789 thousand, compared to $8,180 thousand for the year ended December 31, 2022. The decrease of $391 thousand, or 5%, was attributable to a decrease of $448 thousand in media product sales within our biomedical market segment primarily due to lower sales volume based on customer demand and a decrease of $126 thousand in sales of our skin care products in our anti-aging market segment during 2023 compared to 2022 due to the discontinuation of a product line described below. These decreases were partially offset by an increase of $183 thousand in cell product sales from our biomedical market segment. Our original equipment manufacturer (“OEM”) sales in our biomedical market segment have remained fairly stable year-over-year, with OEM purchasing activity accounting for approximately 58% of sales in this market segment. In 2023, there was a change in the mix of sales from OEM customers as cell sales increased and media sales decreased. As media sales typically account for approximately 70% of sales in our biomedical market segment, the decrease in sales is primarily driven by the decrease in media sales. The change in the mix of sales is believed to be the result of normalization of OEM planning systems and lead time measurement post COVID-19 supply chain challenges. Our professional line of anti-aging products was discontinued in 2022 resulting in only one product line and less overall demand. Our professional anti-aging product line is sold to consumers exclusively through our ecommerce channel with less marketing and store front or medical office exposure contributing to the decrease in product sales. In addition, high percentage promotions were decreased leading to a lesser volume of transactions. Cost of Sales Cost of sales for the year ended December 31, 2023 was $3,181 thousand, compared to $3,269 thousand for the year ended December 31, 2022. The decrease of $88 thousand, or 3%, was primarily attributable a lower cost of direct materials used in products from both the biomedical and anti-aging market segments of $158 thousand and a decrease of freight and shipping costs of $24 thousand. This decrease was partially offset by higher salaries and benefits, including stock-based compensation, of $52 thousand and an increase in overhead and general laboratory supplies of $29 thousand. Profit margin was 59% for the year ended December 31, 2023 as compared to 60% for the year ended December 31, 2022. The decrease in profit margin was primarily driven by manufacturing inefficiencies as a result of less sales. Cost of sales consists primarily of salaries and benefits associated with employee efforts expended directly on the production of the Company’s products, as well as related direct materials, general laboratory supplies and an allocation of overhead. We aim to continue refining our manufacturing processes and supply chain management to improve the cost of sales as a percentage of revenue for both LCT and LSC. 31 General and Administrative Expenses General and administrative expenses for the year ended December 31, 2023 was $3,514 thousand, compared to $3,357 thousand for the year ended December 31, 2022. The increase of $157 thousand, or 5%, was primarily attributable to an increase in consulting, audit, and brokers fees of $246 thousand combined with higher salaries and benefits, including stock-based compensation, of $32 thousand, and an increase in logistics costs of $17 thousand. These increases were partially offset by decreases in legal expenses and directors and officers insurance fees of $93 thousand, a decrease in licenses and permit fees of $32 thousand, and a decrease in meals and entertainment expense of $14 thousand. Our general and administrative expenses consist primarily of employee-related expenses including salaries, bonuses, benefits and stock-based compensation. Other significant costs include facility costs not otherwise included in or allocated to other departments, corporate legal fees not relating to patents, and fees for accounting and consulting services. Selling and Marketing Expenses Selling and marketing expenses for the year ended December 31, 2023 was $1,246 thousand, compared to $1,245 thousand for the year ended December 31, 2022. Overall sales and marketing expenses have remained relatively flat year-over-year with an increase of $72 thousand in consulting fees largely offset by a decrease in logistics of $27 thousand, a decrease in advertising costs of $17 thousand, a decrease in personnel-related costs, including sales commissions, of $8 thousand, and a decrease in subscriptions and dues of $7 thousand. The change in expense year-over-year is primarily attributable to changes in our anti-aging market segment. Our sales and marketing expenses consist primarily of personnel-related expenses, such as salaries, benefits, and stock-based compensation, facility costs not otherwise included in or allocated to other departments, as well as marketing material costs, permits and licenses for ecommerce, and other advertising type expenses. Research and Development Expenses Research and development expenses for the year ended December 31, 2023 was $511 thousand, compared to $492 thousand for the year ended December 31, 2022. The increase of $19 thousand, or 4%, was primarily attributable to a $128 thousand increase in personnel-related costs from increased salaries and stock-based compensation awards granted. The increase was partially offset by a decrease in general lab expenses and materials of $37 thousand, a decrease in the Astellas licensing fees of $31 thousand from the expiration of the licensing agreement in July 2022, and a decrease in consulting fees of $18 thousand. The increase is also offset by an increase of $21 thousand in our Australian research and development tax credit related to qualifiable expenditures from our research and development activities of our Australian subsidiary, Cyto Therapeutics. Our research and development efforts are primarily focused on the development of treatments for Parkinson’s disease, traumatic brain injury, liver diseases, stroke, and the creation of new GMP 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. Research and development expenses are expensed as incurred and are accounted for on a project-by-project basis. However, much of our research has potential applicability to each of our projects. Other Income (Expense), Net Other income, net for the year ended December 31, 2023 was a $532 thousand compared to other expense, net of $148 thousand for the year ended December 31, 2022. Other income of $671 thousand was primarily attributable to a one-time receipt of the Employee Retention Tax Credit for certain employment taxes enacted by the U.S. government in response to the COVID-19 outbreak of $663 thousand in 2023 (refer to Note 8 – Employee Retention Credit within the accompanying consolidated financial statements for further discussion), which was partially offset by other expense. Other expense in both periods primarily relate to interest expense on our related party note payable (refer to Note 10 – Related Party Transactions within the accompanying consolidated financial statements for further discussion). Liquidity and Capital Resources The Company enters into contracts in the normal course of business with various third-party consultants and contract research organizations (“CRO”) for preclinical research, clinical trials and manufacturing activities. These contracts generally provide for termination upon notice. Actual expenses associated with these arrangements may be higher or lower due to various reasons, including but not limited to, progress of our development products, and enrollment in clinical trials. Other short-term and long-term commitments that would affect liquidity include lease obligations as well as related party debt repayments. 32 As of December 31, 2023, we had an accumulated deficit of approximately $110.5 million and have, on an annual basis, incurred net losses and negative operating cash flows since inception. Substantially all of our operating losses have resulted from the funding of our research and development programs and general and administrative expenses associated with our operations. We incurred net losses of $131 thousand, which includes the one-time receipt of the Employee Retention Tax Credit of $663 thousand, and $331 thousand for years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, we had cash of $1.6 million, compared to $742 thousand as of December 31, 2022. Licensed Patents The Company had a minimum annual license fee of $75 thousand payable in two installments per year to Astellas Pharma pursuant to the amended UMass IP license agreement. The patents, along with the license agreement, expired at the end of July 2022. These patents were fully impaired in prior years and therefore the expiration did not result in any additional impairment for the year ended December 31, 2022. The Company does not anticipate any short-term liquidity effects from this obligation as we will no longer be liable for the annual licensing fee. Cash Flows Comparison of the Years Ended December 31, 2023 and 2022 The following table provides information regarding our cash flows for the years ended December 31, 2023 and 2022 (in thousands): Year Ended December 31, 2023 2022 Net cash provided by operating activities $ 929 $ 332 Net cash used in investing activities (83 ) (11 ) Net cash provided by financing activities — 250 Net increase in cash $ 846 $ 571 Operating Cash Flows For the year ended December 31, 2023, net cash provided by operating activities was $929 thousand, resulting primarily from our net loss of $131 thousand, which includes the one-time receipt of the Employee Retention Tax Credit of $663 thousand, and net changes in operating assets and liabilities of $100 thousand, consisting primarily of an increase in accounts payable of $42 thousand, and decreases in operating lease liabilities of $229 thousand, accounts receivable of $173 thousand, and inventories of $141 thousand. The decrease in cash is offset by recurring non-cash adjustments to net income of $960 thousand, including depreciation and amortization expense, stock-based compensation expense, operating lease expense, and related party note payable interest expense. For the year ended December 31, 2022, net cash provided by operating activities was $332 thousand, resulting primarily from our net loss of $331 thousand and changes in operating assets and liabilities of $226 thousand, partially offset by recurring non-cash adjustments to net income of $890 thousand, including depreciation and amortization expense, stock-based compensation expense, operating lease expense, and interest expense. Investing Cash Flows Net cash used in investing activities for the year ended December 31, 2023 was $83 thousand, compared to $11 thousand for the year ended December 31, 2022. The increase in cash used in investing activities was primarily attributable to an increase in purchases of property and equipment of $79 thousand for leasehold improvements, partially offset by a decrease in payments for patent licenses of $7 thousand from 2023 compared to 2022. Financing Cash Flows For year ended December 31, 2023, no net cash was provided by financing activities compared to $250 thousand cash provided for the year ended December 31, 2022. For the year ended December 31, 2022, cash provided by financing activities was wholly attributable to proceeds from our related party note payable (refer to Note 10 – Related Party Transactions within the accompanying consolidated financial statements for further discussion). 33 Going Concern Management continues to evaluate 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 exercise of outstanding warrants, equity and/or debt financings, license arrangements, grants and/or collaborative research arrangements to sustain our operations and develop products. Unless we obtain additional financing, we do not have sufficient cash on hand to sustain our operations at least through one year after the issuance date. The timing and degree of any future capital requirements will depend on many factors, including: • the accuracy of the assumptions underlying the estimates for capital needs in 2024 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 pre-clinical development and clinical trials; • the extent to which third party interest in Company’s research and commercial products can be realized through effective partnerships; • the time and costs involved in obtaining regulatory approvals; • the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims; • the number and type of product candidates that we pursue; and • the development of major public health concerns, such as the novel coronavirus outbreak, or other pandemics arising globally, and its impact on our business operations and funding requirements. Our failure to raise capital or enter into applicable arrangements when needed would have a negative impact on our financial condition. Additional debt financing may be expensive and require us to pledge all or a substantial portion of its assets. Further, if additional funds are obtained through arrangements with collaborative partners, these arrangements may require us to relinquish rights to some of its technologies, product candidates or products that we would otherwise seek to develop and commercialize on its own. If sufficient capital is not available, we may be required to delay, reduce the scope of or eliminate one or more of its product initiatives. We currently have no revenue generated from our principal operations in therapeutic and clinical product development through research and development efforts. There can be no assurance that we will be successful in maintaining our normal operating cash flow and obtaining additional funds and that the timing of our capital raising, or future financing will result in cash flow sufficient to sustain our operations at least through one year after the issuance date. Based on the factors 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. Critical Accounting 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 United States. 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, and 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. Our significant accounting policies are more fully described in Note 1 – Description of Business and Summary of Significant Accounting Policies to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Our most critical 34 accounting estimates include current and non-current inventories and stock-based compensation. We review our estimates and assumptions periodically and reflect the effects of revisions in the period in which they are deemed to be necessary. We believe that the following accounting policies are critical to the judgments and estimates used in preparation of our consolidated financial statements. Allowance for Excess and Obsolete Inventory Our inventories, particularly within our biomedical market, consist of certain products that have a long or, when frozen, indefinite shelf life. In addition, future demand for our products is uncertain. Accordingly, at each reporting period, we estimate a reserve for allowance for excess and obsolete inventory. This estimate is computed using historical sales data and inventory turnover rates, which are subjective in nature and fluctuate between periods. The establishment of a reserve for excess and obsolete inventory establishes a new cost basis in the inventory with a corresponding adjustment to cost of sales. If we are able to sell such inventory, any related reserves are reduced in the period of sale. The Company's allowance for excess and obsolete inventory was $739 thousand and $637 thousand as of December 31, 2023 and 2022, respectively. A 10% change in our reserve estimate in total as of December 31, 2023 would result in a change in reserve of approximately $74 thousand. Our reserves are estimates, which could vary significantly, either favorably or unfavorably, from actual results if future economic conditions, consumer demand and competitive environments differ from our expectations. Stock-Based Compensation We are required to measure and recognize compensation expense for all stock-based payment awards made to employees and consultants based on estimated fair value. We estimate the fair value of stock options granted using the Black-Scholes option-pricing model. The determination of fair value of stock-based awards using the Black-Scholes option-pricing model requires the use of certain estimates and subjective assumptions that affect the amount of stock-based compensation expense recognized in our consolidated statements of operations. These include estimates of the expected volatility of our stock price, expected option life, expected dividends and the risk-free interest rate. Estimated volatility is a measure of the amount by which our stock price is expected to fluctuate each year during the expected life of the award. The expected option life is calculated using the Simplified Method as prescribed by accounting guidance for stock-based compensation. We determined expected dividend yield to be 0% given that we have never declared or paid any cash dividends on our common stock, and we currently do not anticipate paying such cash dividends. The risk-free interest rate is based upon United States Treasury securities with remaining terms similar to the expected term of the stock-based awards. If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense may differ materially from what we have recorded in the current period. Recently Issued Accounting Pronouncements A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is disclosed in Note 1 – Description of Business and Summary of Significant Accounting Policies to our consolidated financial statements included in this Annual Report on Form 10-K. 35 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not required. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required by this Item is set forth in our consolidated financial statements and accompanying notes thereto beginning at Page F-1 of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None.