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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended: June 30, 2010
Commission File Number: 0-19871
STEMCELLS, INC.
(Exact name of registrant as specified in its charter)
     
DELAWARE   94-3078125
     
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
identification No)
3155 PORTER DRIVE
PALO ALTO, CA 94304
 
(Address of principal executive offices including zip code)
(650) 475-3100
 
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter periods that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
At August 6, 2010, there were 127,204,695 shares of Common Stock, $.01 par value, issued and outstanding.
 
 

 


 

STEMCELLS, INC.
INDEX
         
    Page Number  
    3  
    3  
    3  
    4  
    5  
    6  
    18  
    30  
    30  
    30  
    30  
    31  
    31  
    31  
    31  
    32  
    32  
    33  
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
NOTE REGARDING REFERENCES TO US AND OUR COMMON STOCK
Throughout this Form 10-Q, the words “we,” “us,” “our,” and “StemCells” refer to StemCells, Inc., including our directly and indirectly wholly-owned subsidiaries. “Common stock” refers to the common stock, $.01 par value, of StemCells, Inc.

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PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STEMCELLS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
                 
    June 30, 2010     December 31, 2009  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 30,765,504     $ 38,617,977  
Marketable securities, current
    124,962       196,995  
Trade receivables
    13,920       87,019  
Other receivables
    521,939       679,034  
Prepaid assets
    692,045       560,144  
 
           
Total current assets
    32,118,370       40,141,169  
Property, plant and equipment, net
    2,731,229       2,856,695  
Other assets, non-current
    2,537,500       2,525,185  
Goodwill
    1,823,039       2,019,679  
Other intangible assets, net
    3,183,502       3,647,596  
 
           
Total assets
  $ 42,393,640     $ 51,190,324  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 605,011     $ 890,582  
Accrued expenses and other current liabilities
    2,368,791       3,760,438  
Accrued wind-down expenses, current
    1,571,384       1,449,810  
Deferred revenue, current
    91,252       119,542  
Capital lease obligation, current
    64,547       68,000  
Deferred rent, current
    55,123       80,392  
Bonds payable, current
    168,750       161,250  
 
           
Total current liabilities
    4,924,858       6,530,014  
Capital lease obligation, non-current
    52,749       85,826  
Bonds payable, non-current
    613,750       698,750  
Fair value of warrant liability
    5,720,249       9,676,968  
Deposits and other long-term liabilities
    466,211       466,211  
Accrued wind-down expenses, non-current
    2,515,767       3,056,675  
Deferred rent, non-current
    16,113       50,600  
Deferred revenue, non-current
    121,800       130,213  
 
           
Total liabilities
    14,431,497       20,695,257  
Commitments and contingencies (Note 8)
               
Stockholders’ equity:
               
Common stock, $0.01 par value; 250,000,000 shares authorized; issued and outstanding 127,160,886 at June 30, 2010 and 118,349,587 at December 31, 2009
    1,271,609       1,183,495  
Additional paid-in capital
    323,536,882       314,944,784  
Accumulated deficit
    (296,762,357 )     (286,027,935 )
Accumulated other comprehensive income
    (83,991 )     394,723  
 
           
Total stockholders’ equity
    27,962,143       30,495,067  
 
           
Total liabilities and stockholders’ equity
  $ 42,393,640     $ 51,190,324  
 
           
See Notes to Condensed Consolidated Financial Statements.

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STEMCELLS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
                                 
    Three months ended     Six months ended  
    June 30,     June 30,  
    2010     2009     2010     2009  
Revenue:
                               
Revenue from licensing agreements and grants
  $ 171,550     $ 144,851     $ 285,399     $ 201,453  
Revenue from product sales
    72,581       120,600       189,005       120,600  
 
                       
Total revenue
    244,131       265,451       474,404       322,053  
Cost of product sales
    24,862       59,525       68,624       59,525  
 
                       
Gross profit
    219,269       205,926       405,780       262,528  
Operating expenses:
                               
Research and development
    4,858,228       5,054,600       9,895,742       9,290,389  
Selling, general and administrative
    2,286,678       2,201,974       4,871,420       4,740,886  
Wind-down expenses
    125,833       340,064       291,168       545,500  
 
                       
Total operating expenses
    7,270,739       7,596,638       15,058,330       14,576,775  
 
                       
Loss from operations
    (7,051,470 )     (7,390,712 )     (14,652,550 )     (14,314,247 )
Other income (expense):
                               
Realized gain on sale of marketable securities
                      397,866  
Change in fair value of warrant liability
    2,440,370       102,517       3,956,719       (2,652,931 )
Interest income
    13,309       8,338       13,903       50,285  
Interest expense
    (25,054 )     (29,074 )     (50,554 )     (57,250 )
Other income (expense)
    12,498       (57,424 )     (1,940 )     (71,634 )
 
                       
Total other income (expense), net
    2,441,123       24,357       3,918,128       (2,333,664 )
 
                       
Net loss
  $ (4,610,347 )   $ (7,366,355 )   $ (10,734,422 )   $ (16,647,911 )
 
                       
Basic and diluted net loss per share
  $ (0.04 )   $ (0.07 )   $ (0.09 )   $ (0.17 )
Shares used to compute basic and diluted loss per share
    119,905,731       104,776,073       119,435,048       100,436,291  
See Notes to Condensed Consolidated Financial Statements.

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STEMCELLS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
                 
    Six months ended  
    June 30,  
    2010     2009  
Cash flows from operating activities:
               
Net loss
  $ (10,734,422 )   $ (16,647,911 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    789,911       754,863  
Stock-based compensation
    2,122,513       2,038,757  
Gain on sale of marketable securities
          (397,868 )
Loss on disposal of fixed assets
    1,766        
Write-down of fixed assets
    62,807        
Change in fair value of warrant liability
    (3,956,719 )     2,652,931  
Changes in operating assets and liabilities:
               
Other receivables
    (10,016 )     236,805  
Trade receivables
    260,139       231,182  
Prepaid and other current assets
    (134,510 )     (199,428 )
Other assets, non-current
    (14,616 )     (16,070 )
Accounts payable and accrued expenses
    (1,636,661 )     (551,038 )
Accrued wind-down expenses
    (413,798 )     (200,406 )
Deferred revenue
    (22,811 )     (118,140 )
Deferred rent
    (59,756 )     (166,501 )
 
           
Net cash used in operating activities
    (13,746,173 )     (12,382,824 )
Cash flows from investing activities:
               
Proceeds from the sale of marketable securities
          4,512,750  
Payment of advances under notes receivable
          (79,829 )
Purchases of property, plant and equipment
    (509,064 )     (379,732 )
Acquisition of other assets
          (15,000 )
 
           
Net cash provided by (used in) investing activities
    (509,064 )     4,038,189  
 
           
Cash flows from financing activities:
               
Proceeds from issuance of common stock, net of issuance costs
    7,015,322       14,987,348  
Proceeds from the exercise of stock options
    18,936       175,992  
Proceeds from the exercise of warrants
          331,501  
Payments related to net share issuance of stock based awards
    (476,559 )     (380,548 )
Proceeds from (repayment of) capital lease obligations
    (36,530 )     166,659  
Repayment of bonds payable
    (77,500 )     (72,500 )
 
           
Net cash provided by financing activities
    6,443,669       15,208,452  
 
           
Increase (decrease) in cash and cash equivalents
    (7,811,568 )     6,863,817  
Effects of foreign exchange rate changes on cash
    (40,905 )     (146,333 )
Cash and cash equivalents, beginning of period
    38,617,977       30,042,986  
 
           
Cash and cash equivalents, end of period
  $ 30,765,504     $ 36,760,470  
 
           
Supplemental disclosure of cash flow information:
               
Interest paid
  $ 50,554     $ 57,250  
 
           
Supplemental schedule of non-cash investing and financing activities:
               
Stock issued as part of our acquisition of the operations of SCS Plc (1)
          $ 4,425,500  
Forgiveness of principal and accrued interest on notes receivable (1)
          $ 709,076  
 
(1)   On April 1, 2009, we acquired the operations of Stem Cell Sciences Plc (SCS). As consideration, we issued to SCS 2,650,000 shares of common stock with a closing price of $1.67 per share and waived certain commitments of SCS to repay approximately $709,000 in principal and accrued interest owed to us.
See Notes to Condensed Consolidated Financial Statements.

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Notes to Condensed Consolidated Financial Statements (Unaudited)
June 30, 2010 and 2009
Note 1. Summary of Significant Accounting Policies
Nature of Business
     StemCells, Inc., a Delaware corporation, is a biopharmaceutical company that operates in one segment, the research, development, and commercialization of stem cell therapeutics and related technologies.
     The accompanying financial data as of and for the three and six months ended June 30, 2010 and 2009 has been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) have been condensed or omitted pursuant to these rules and regulations. The December 31, 2009 condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. However, we believe that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
     We have incurred significant operating losses since inception. We expect to incur additional operating losses over the foreseeable future. We have very limited liquidity and capital resources and must obtain significant additional capital and other resources in order to provide funding for our product development efforts, the acquisition of technologies, businesses and intellectual property rights, preclinical and clinical testing of our investigative products, pursuit of regulatory approvals, acquisition of capital equipment, laboratory and office facilities, establishment of production capabilities, selling, general and administrative expenses and other working capital requirements. We rely on our cash reserves, proceeds from equity and debt offerings, proceeds from the transfer or sale of intellectual property rights, equipment, facilities or investments, government grants and funding from collaborative arrangements, to fund our operations. If we exhaust our cash reserves and are unable to obtain adequate financing, we may be unable to meet our operating obligations and we may be required to initiate bankruptcy proceedings. The 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.
Principles of Consolidation
     The condensed consolidated financial statements include the accounts of StemCells, Inc., and our wholly-owned subsidiaries, StemCells California, Inc., StemCells Property Holding LLC, Stem Cell Sciences Holdings Ltd; Stem Cell Sciences (UK) Ltd; and Stem Cell Sciences (Australia) Pty Ltd. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
     The preparation of financial statements in conformity with U.S. GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Actual results could differ materially from these estimates.
     Significant estimates include the following:
    the grant date fair value of stock-based awards recognized as compensation expense (see Note 6, “Stock-Based Compensation”);
 
    accrued wind-down expenses (see Note 7, “Wind-Down Expenses”);
 
    the fair value of warrants recorded as a liability (see Note 9, “Warrant Liability”); and
 
    the fair value of goodwill and other intangible assets (see Note 5, “Goodwill and Other Intangible Assets”).

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Financial Instruments
  Cash and Cash Equivalents
     Cash equivalents are money market accounts, money market funds and investments with an average maturity of 90 days or less from the date of purchase.
  Marketable Securities
     Our existing marketable securities are designated as available-for-sale securities. These securities are carried at fair value (see Note 2, “Financial Instruments”), with the unrealized gains and losses reported as a component of stockholders’ equity. Management determines the appropriate designation of its investments (current or non-current) in marketable securities at the time of purchase and reevaluates such designation as of each balance sheet date. The cost of securities sold is based upon the specific identification method.
     If the estimated fair value of a security is below its carrying value, we evaluate whether we have the intent and ability to retain our investment for a period of time sufficient to allow for any anticipated recovery to the cost of the investment, and whether evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Other-than-temporary declines in estimated fair value of all marketable securities are charged to “Other income (expense), net.” No such impairment was recognized during the six months ended June 30, 2010 or 2009.
  Trade and Other Receivables
     Our receivables generally consist of interest income on our financial instruments, revenue from licensing agreements and grants, revenue from product sales, and rent from our sub-lease tenants.
  Warrant Liability
     Authoritative accounting guidance prescribes that warrants issued under contracts that could require net-cash settlement should be classified as liabilities and contracts that only provide for settlement in shares should be classified as equity. In order for a contract to be classified as equity, specific conditions must be met. These conditions are intended to identify situations in which net cash settlement could be forced upon the issuer. We issued warrants as part of both our November 2008 and November 2009 financings (see Note 9, “Warrant Liability”). As the contracts include the possibility of net-cash settlement, we are required to classify the fair value of the warrants issued as a liability, with subsequent changes in fair value to be recorded as income (loss) on change in fair value of warrant liability. We use the Black-Scholes option pricing model to estimate fair value of warrants issued. In using this model, we make certain assumptions about risk-free interest rates, dividend yields, volatility and expected term of the warrants. Risk-free interest rates are derived from the yield on U.S. Treasury debt securities. Dividend yields are based on our historical dividend payments, which have been zero to date. Volatility is derived from the historical volatility of our common stock as traded on Nasdaq. The expected term of the warrants is based on the time to expiration of the warrants from the date of measurement.
Goodwill and Other Intangible Assets
     Goodwill and intangible assets are primarily from a business acquisition accounted for under the purchase method. Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment tests. We test goodwill for impairment on an annual basis or more frequently if we believe indicators of impairment exist. Intangible assets with finite useful lives are amortized generally on a straight-line basis over the periods benefited. Intangible assets with finite useful lives are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Prior to fiscal year 2001, we capitalized certain patent costs, which are being amortized over the estimated lives of the patents and would be expensed at the time such patents are deemed to have no continuing value. Since 2001, all patent costs are expensed as incurred. License costs are capitalized and amortized over the estimated life of the license agreement.
Revenue Recognition
     We currently recognize revenue resulting from the licensing and use of our technology and intellectual property. Such licensing agreements may contain multiple elements, such as upfront fees, payments related to the achievement of particular milestones and royalties. Revenue from upfront fees for licensing agreements that contain multiple elements are generally deferred and recognized on a straight-line basis over the term of the agreement. Fees associated with substantive at risk performance-based milestones are recognized as revenue upon completion of the scientific or regulatory event specified in the agreement, and royalties received are recognized as earned. Revenue from licensing agreements are recognized net of a fixed percentage due to licensors as royalties. Grant

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revenue from government agencies are funds received to cover specific expenses and are recognized as earned upon either the incurring of reimbursable expenses directly related to the particular research plan or the completion of certain development milestones as defined within the terms of the relevant collaborative agreement or grant. Revenue from product sales are recognized when the product is shipped and the order fulfilled.
Stock-Based Compensation
     Compensation expense for stock-based payment awards to employees is based on their grant date fair value as calculated and amortized over their vesting period. See Note 6, “Stock-Based Compensation” for further information.
     We use the Black-Scholes-Merton (Black-Scholes) model to calculate the fair value of stock-based awards.
Net Loss per Share
     Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed based on the weighted-average number of shares of common stock and other dilutive securities. To the extent these securities are anti-dilutive, they are excluded from the calculation of diluted earnings per share.
     The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:
                                 
    Three months ended June 30,     Six months ended June 30,  
    2010     2009     2010     2009  
Net loss
  $ (4,610,347 )   $ (7,366,355 )   $ (10,734,422 )   $ (16,647,911 )
Weighted average shares outstanding used to compute basic and diluted net loss per share
    119,905,731       104,776,073       119,435,048       100,436,291  
Basic and diluted net loss per share
  $ (0.04 )   $ (0.07 )   $ (0.09 )   $ (0.17 )
     The following outstanding potentially dilutive common stock equivalents were excluded from the computation of diluted net loss per share because the effect would have been anti-dilutive as of June 30:
                 
    2010     2009  
Options
    11,498,991       9,380,197  
Restricted stock units
    4,888,388       2,303,068  
Warrants
    14,344,828       10,344,828  
 
           
Total
    30,732,207       22,028,093  
 
           
Comprehensive Loss
     Comprehensive loss is comprised of net losses and other comprehensive loss or income (OCL). OCL includes certain changes in stockholders’ equity that are excluded from net losses. Specifically, we include in OCL changes in unrealized gains and losses on our marketable securities and unrealized gains and losses on foreign currency translations. Accumulated other comprehensive loss was $83,991 as of June 30, 2010 and accumulated other comprehensive income was $394,723 as of December 31, 2009.
     The activity in OCL was as follows:
                                 
    Three months ended June 30,     Six months ended June 30,  
    2010     2009     2010     2009  
Net loss
  $ (4,610,347 )   $ (7,366,355 )   $ (10,734,422 )   $ (16,647,911 )
Net change in unrealized gains and losses on marketable securities
    (31,769 )     83,279       (72,034 )     133,760  
Net change in unrealized gains and losses on foreign currency translations
    (96,462 )     (225,638 )     (406,680 )     (225,638 )
 
                       
Comprehensive loss
  $ (4,738,578 )   $ (7,508,714 )   $ (11,213,136 )   $ (16,739,789 )
 
                       
Recent Accounting Pronouncements
     In January 2010, the Financial Accounting Standards Board (FASB), issued new standards to update and amend existing standards on Fair Value Measurements and Disclosures. These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and Level 2 fair value measurements. The standards also require disclosure of activities in Level 3 fair value

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measurements that use significant unobservable inputs, including purchases, sales, issuances, and settlements. The standards also clarify existing disclosure requirements on levels of disaggregation, which requires fair value measurement disclosure for each class of assets and liabilities, and disclosures about valuation techniques and inputs used to measure fair value of recurring and non recurring fair value measurements that fall in ether Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for our interim and annual reporting periods beginning January 1, 2010, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for our fiscal year beginning January 1, 2011. We do not expect the adoption of the new standards related to Level 3 fair value measurements on January 1, 2011 to have a material effect on our consolidated financial condition and results of operations.
     In April 2010, FASB issued Accounting Standards Update (ASU), Revenue Recognition—Milestone Method, which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Research or development arrangements frequently include payment provisions whereby a portion or all of the consideration is contingent upon milestone events such as successful completion of phases in a study or achieving a specific result from the research or development efforts. The amendments in this ASU provide guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. The ASU is effective for fiscal years and interim periods within those years beginning on or after June 15, 2010, with early adoption permitted. This ASU is effective for our interim and annual reporting periods beginning January 1, 2011. We are currently evaluating the impact of this new standard, if any, on our financial condition and results of operations.
Note 2. Financial Instruments
     The following table summarizes the fair value of our cash, cash equivalents and available-for-sale marketable securities held in our current investment portfolio:
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized        
    Cost     Gains     (Losses)     Fair Value  
June 30, 2010
                               
Cash
  $ 6,461,873     $     $     $ 6,461,873  
Cash equivalents
    24,303,631                   24,303,631  
Marketable equity securities, current
    74,456       50,506             124,962  
 
                       
Total cash, cash equivalents, and marketable securities
  $ 30,839,960     $ 50,506     $     $ 30,890,466  
 
                       
December 31, 2009
                               
Cash
  $ 1,064,148     $     $     $ 1,064,148  
Cash equivalents
    37,553,829                   37,553,829  
Marketable equity securities, current
    74,456       122,539             196,995  
 
                       
Total cash, cash equivalents, and marketable securities
  $ 38,692,433     $ 122,539     $     $ 38,814,972  
 
                       
     Gross unrealized gains and losses on cash equivalents were not material at June 30, 2010 and December 31, 2009. At June 30, 2010, our cash equivalents were primarily money market funds consisting mainly of U.S. Treasury debt securities.
     Our investment in marketable equity securities consists of ordinary shares of ReNeuron Group Plc (ReNeuron), a publicly listed U.K. corporation. In July 2005, we entered into an agreement with ReNeuron under which we granted ReNeuron a license that allows ReNeuron to exploit its “c-mycER” conditionally immortalized adult human neural stem cell technology for therapy and other purposes. We received shares of ReNeuron common stock, as well as a cross-license to the exclusive use of ReNeuron’s technology for certain diseases and conditions, including lysosomal storage diseases, spinal cord injury, cerebral palsy, and multiple sclerosis. The agreement also provides for full settlement of any potential claims that either we or ReNeuron might have had against the other in connection with any putative infringement of certain of each party’s patent rights prior to the effective date of the agreement. In July and August 2005, we received approximately 8,836,000 ordinary shares of ReNeuron common stock, net of approximately 104,000 shares that were transferred to NeuroSpheres, Ltd., an Alberta corporation (NeuroSpheres), and subsequently, as a result of certain anti-dilution provisions in the agreement, we received approximately 1,261,000 more shares, net of approximately 18,000 shares that were transferred to NeuroSpheres. In February 2007, we sold 5,275,000 shares for net proceeds of approximately $3,075,000. We recognized approximately $716,000 as realized gain from this transaction. In the first quarter of 2009, we sold 2,900,000 shares of ReNeuron and received net proceeds of approximately $510,000 for a realized gain of approximately $398,000. At June 30, 2010 and December 31, 2009, we owned 1,921,924 shares of ReNeuron with a carrying and fair market value of approximately $125,000 and $197,000 respectively.

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     Changes in the fair market value of our ReNeuron shares as a result of changes in market price per share or the exchange rate between the U.S. dollar and the British pound are accounted for as an unrealized gain or loss under “other comprehensive income (loss)” if deemed temporary and are not recorded as “other income (expense), net” until the shares are disposed of and a gain or loss realized. If the fair value of a security is below its carrying value, we evaluate whether we have the intent and ability to retain our investment for a period of time sufficient to allow for any anticipated recovery to the cost of the investment, and whether evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. Other-than-temporary declines in estimated fair value of all marketable securities are charged to “other income (expense), net.” For the six months ended June 30, 2010, we recorded an unrealized loss of approximately $72,000.
Note 3. Fair Value Measurement
     The following tables present our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value.
    Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
 
    Level 2 — Directly or indirectly observable inputs other than in Level 1, that include quoted prices for similar assets or liabilities in active markets or quoted prices for identical or similar assets or liabilities in markets that are not active.
 
    Level 3 — Unobservable inputs which are supported by little or no market activity that reflects the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.
     The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
     Our cash equivalents, marketable securities, bonds payable and warrant liability are classified within Level 1 or Level 2. This is because our cash equivalents and marketable securities are valued primarily using quoted market prices, our bonds payable are valued using alternative pricing sources and models utilizing market observable inputs and our warrant liability is valued using an option pricing model that uses assumptions with observable inputs such as risk-free interest rates that are derived from the yield on U.S. Treasury debt securities, volatility and price based on our common stock as traded on Nasdaq.
     We currently do not have any Level 3 financial assets or liabilities.
     The following table presents financial assets and liabilities measured at fair value:
                         
    Fair Value Measurement        
    at Reporting Date Using        
    Quoted Prices     Significant        
    in Active Markets     Other        
    for     Observable     As of  
    Identical Assets     Inputs     June 30,  
    (Level 1)     (Level 2)     2010  
Financial assets
                       
Cash equivalents:
                       
Money market funds
  $ 30,765,504     $     $ 30,765,504  
Marketable securities:
                       
Equity securities
    124,962             124,962  
 
                 
Total financial assets
  $ 30,890,466             30,890,466  
 
                 
Financial liabilities
                       
Bond payable
  $     $ 782,500     $ 782,500  
Warrant liability
  $       5,720,249       5,720,249  
 
                 
Total financial liabilities
  $     $ 6,502,749     $ 6,502,749  
 
                 
Note 4. Acquisition of Stem Cell Sciences Plc (SCS) Operations
     On April 1, 2009, we acquired the operations of SCS for an aggregate purchase price of approximately $5,135,000. The acquired operations includes proprietary cell technologies relating to embryonic stem cells, induced pluripotent stem (iPS) cells, and tissue-

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derived (adult) stem cells; expertise and infrastructure for providing cell-based assays for drug discovery; a cell culture products business; and an intellectual property portfolio with claims relevant to cell processing, reprogramming and manipulation, as well as to gene targeting and insertion.
     The purchase price has been allocated as follows:
                 
            Estimated life of  
    Allocated purchase     intangible assets  
    price     in years  
Net tangible assets
  $ 36,000          
Intangible assets:
               
Customer relationships and developed technology
    1,310,000       6 to 9  
In process research and development
    1,340,000       13 to 19  
Trade name
    310,000       15  
Goodwill
    2,139,000       N/A  
 
             
Total
  $ 5,135,000          
Note 5. Goodwill and Other Intangible Assets
     In March 2010, we received approximately $47,000 for an R&D tax credit due to our wholly-owned subsidiary Stem Cell Sciences (Australia) Pty Ltd. The R&D tax credit was due for the year 2007. Accordingly, the purchase price allocation for the SCS acquisition was adjusted and the gross carrying amount of goodwill recorded at the date of acquisition was reduced by that amount.
     The following table represents changes in goodwill:
         
Balance as of December 31, 2009
  $ 2,019,679  
Reductions (R&D credit as described above)
    (47,374 )
Foreign currency translation
    (149,266 )
 
     
Balance as of June 30, 2010
  $ 1,823,039  
 
     
     The components of our other intangible assets at June 30, 2010 are summarized below:
         
    Net Carrying  
Other Intangible Asset Class   Amount  
Customer relationships and developed technology
  $ 1,141,914  
In-process research and development
    1,274,949  
Trade name
    294,920  
Patents
    380,652  
License agreements
    91,067  
 
     
Total other intangible assets
  $ 3,183,502  
 
     
     Amortization expense was approximately $103,000 in the second quarter of 2010.
Note 6. Stock-Based Compensation
     We currently grant stock-based awards under three equity incentive plans. We had 23,759,050 shares authorized to be granted under the three plans as of June 30, 2010. Under these plans we may grant various types of equity awards to our employees, directors and consultants, at prices determined by our Board of Directors, including incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, and performance-based shares. Incentive stock options may only be granted to employees under these plans with a grant price not less than the fair market value of the stock on the date of grant. We use these plans to grant shares to employees for the employer match of employee 401(k) plan contributions.
     Our stock-based compensation expense for the three and six months ended June 30 was as follows:
                                 
    Three months ended     Six months ended  
    June 30,     June 30,  
    2010     2009     2010     2009  
Research and development expense
  $ 613,330     $ 556,145     $ 1,159,938     $ 1,048,732  
Selling, general and administrative expense
    490,212       501,597       962,576       990,025  
 
                       
Total employee stock-based compensation expense and effect on net loss
  $ 1,103,542     $ 1,057,742     $ 2,122,514     $ 2,038,757  
 
                       
Effect on basic and diluted net loss per share
  $ (0.01 )   $ (0.01 )   $ (0.02 )   $ (0.02 )
 
                       

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     As of June 30, 2010, we had approximately $8,803,000 of total unrecognized compensation expense related to unvested awards of stock options and restricted stock units granted under our various equity incentive plans that we expect to recognize over a weighted-average vesting period of 2.9 years.
  Stock Options
     Generally, stock options granted to employees have a maximum term of ten years, and vest over a four year period from the date of grant; 25% vest at the end of one year, and 75% vest monthly over the remaining three-year service period. We may grant options with different vesting terms from time to time. Upon employee termination of service, any unexercised vested option will be forfeited three months following termination or the expiration of the option, whichever is earlier. Unvested options are forfeited on termination.
     A summary of our stock option activity for the three months ended June 30, 2010 is as follows:
                 
            Weighted-average  
    Number of options     exercise price ($)  
Balance at March 31, 2010
    9,830,870       2.20  
Granted
    1,883,000       1.03  
Exercised
    (30,000 )     0.61  
Cancelled
    (184,879 )     2.21  
 
           
Outstanding options at June 30, 2010
    11,498,991       2.02  
 
           
     The estimated weighted-average fair value of options granted in the three months ended June 30, 2010 and 2009 was approximately $0.81 and $1.41 per option, respectively. The fair value of options granted is estimated as of the date of grant using the Black-Scholes option pricing model, which requires certain assumptions as of the date of grant. The weighted-average assumptions used as of June 30, 2010 and 2009 were as follows:
                                 
    Three months ended June 30,     Six months ended June 30,  
    2010     2009     2010     2009  
Expected life (years)(1)
    7.4       7.4       7.2       7.4  
Risk-free interest rate(2)
    2.9 %     2.8 %     2.9 %     2.7 %
Expected volatility(3)
    88.2 %     93.5 %     88.4 %     94.2 %
Expected dividend yield(4)
    0 %     0 %     0 %     0 %
 
(1)   The expected term represents our estimated period during which our stock-based awards remain outstanding. We estimated this period based on historical experience of similar awards, giving consideration to the contractual terms of the awards, vesting requirements, and expectation of future employee behavior, including post-vesting terminations.
 
(2)   The risk-free interest rate is based on U.S. Treasury debt securities with maturities close to the expected term of the option as of the date of grant.
 
(3)   Expected volatility is based on historical volatility over the most recent historical period equal to the length of the expected term of the option as of the date of grant.
 
(4)   We have not historically issued any dividends, and we do not expect to in the foreseeable future.
     At the end of each reporting period, we estimate forfeiture rates based on our historical experience within separate groups of employees and adjust the stock-based compensation expense accordingly.
     A summary of changes in unvested options for the three months ended June 30, 2010 is as follows:
                 
            Weighted-average grant  
    Number of options     date fair value ($)  
Unvested options at March 31, 2010
    2,921,743       1.36  
Granted
    1,883,000       0.81  
Vested
    (542,228 )     1.56  
Cancelled
    (7,708 )     1.36  
 
           
Unvested options at June 30, 2010
    4,254,807       1.09  
 
           

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     The estimated fair value of shares vested were approximately $846,000 in the three months ended June 30, 2010.
  Restricted Stock Units
     We have granted restricted stock units (RSUs) to certain employees which entitle the holders to receive shares of our common stock upon vesting of the RSUs. The fair value of restricted stock units granted are based upon the market price of the underlying common stock as if it were vested and issued on the date of grant.
     A summary of our restricted stock unit activity for the three months ended June 30, 2010 is as follows:
                 
            Weighted-average grant  
    Number of RSUs     date fair value ($)  
Balance at March 31, 2010
    1,777,151       1.58  
Granted
    3,365,000       1.03  
Vested and converted to common shares
    (253,763 )     1.09  
 
           
Balance unvested at June 30, 2010 (1)
    4,888,388       1.23  
 
           
 
(1)   55,000 of these restricted stock units vest and convert into shares of our common stock after one year from the date of grant. 2,580,754 of these restricted stock units vest and convert into shares of our common stock over a three year period from the date of grant: one-third of the award will vest on each grant date anniversary following the grant. 2,092,634 of these restricted stock units vest and convert into shares of our common stock over a four year period from the date of grant: one-fourth of the award will vest on each grant date anniversary following the grant. 160,000 of these restricted stock units will vest and convert into shares of our common stock subject to attainment of certain performance criteria and will be forfeited if not met.
  Stock Appreciation Rights
     In July 2006, we granted cash-settled Stock Appreciation Rights (SARs) to certain employees that give the holder the right, upon exercise, to the difference between the price per share of our common stock at the time of exercise and the exercise price of the SARs.
     The SARs have a maximum term of ten years with an exercise price of $2.00, which is equal to the market price of our common stock at the date of grant. The SARs vest 25% on the first anniversary of the grant date and 75% vest monthly over the remaining three-year service period. Compensation expense is based on the fair value of SARs which is calculated using the Black-Scholes option pricing model. The stock-based compensation expense and liability are re-measured at each reporting date through the date of settlement.
     A summary of the changes in SARs for the three months ended June 30, 2010 is as follows:
         
    Number of SARs  
Outstanding at March 31, 2010
    1,422,853  
Granted
     
Exercised
     
Forfeited and expired
    (68,765 )
 
     
Outstanding SARs at June 30, 2010
    1,354,088  
 
     
SARs exercisable at June 30, 2010
    1,325,872  
 
     
     For the three months ended June 30, 2010, we re-measured the liability related to the SARs and due to a decrease in the price per share of our common stock and forfeiture, the re-measured fair value of the liability reduced compensation expense by approximately $148,000. For the same period in 2009, we recorded compensation expense of approximately $96,000.
     At June 30, 2010, we expect to recognize approximately $6,000 of compensation expense related to SARs over the next three months. The resulting effect on net loss and net loss per share attributable to common stockholders may not be representative of the effects in future periods, due to changes in the fair value calculation which is dependent on the stock price, volatility, interest and forfeiture rates, additional grants and subsequent periods of vesting.

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Note 7. Wind-Down Expenses
  Rhode Island
     In October 1999, we relocated to California from Rhode Island and established a wind down reserve for the estimated lease payments and operating costs of the scientific and administrative facility in Rhode Island. Even though we intend to dispose of the facility at the earliest possible time, we cannot determine with certainty a fixed date by which such disposal will occur. In light of this uncertainty, we periodically re-evaluate and adjust the reserve. We consider various factors such as our lease payments through to the end of the lease, operating expenses, the current real estate market in Rhode Island, and estimated subtenant income based on actual and projected occupancy.
     The summary of the changes to our wind-down reserve related to this facility for 2010 and 2009 were as follows:
                                 
    January 1 to     April 1 to     January 1 to     January 1 to  
    March 31,     June 30,     June 30,     December 31,  
    2010     2010     2010     2009  
Accrued wind-down reserve at beginning of period
  $ 3,572,000     $ 3,422,000     $ 3,572,000     $ 4,448,000  
Less actual expenses recorded against estimated reserve during the period
    (315,000 )     (280,000 )     (595,000 )     (1,216,000 )
Additional expense recorded to revise estimated reserve at period-end
    165,000       126,000       291,000       340,000  
 
                       
Revised reserve at period-end
    3,422,000       3,268,000       3,268,000       3,572,000  
Add deferred rent at period-end
    809,000       758,000       758,000       861,000  
 
                       
Total accrued wind-down expenses at period-end (current and non current)
  $ 4,231,000     $ 4,026,000     $ 4,026,000     $ 4,433,000  
 
                       
Accrued wind-down expenses, current
  $ 1,443,000     $ 1,510,000     $ 1,510,000     $ 1,376,000  
Accrued wind-down expenses, non-current
    2,788,000       2,516,000       2,516,000       3,057,000  
 
                       
Total accrued wind-down expenses
  $ 4,231,000     $ 4,026,000     $ 4,026,000     $ 4,433,000  
 
                       
  Australia
     On April 1, 2009, as part of our acquisition of the SCS operations, we acquired operations near Melbourne, Australia. In order to reduce operating complexity and expenses, we made the decision to close our site in Australia and consolidate personnel and programs to our Cambridge, U.K. and Palo Alto, California sites. U.S. GAAP requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. In accordance with U.S. GAAP requirements, at June 30, 2009, we established a short-term reserve of approximately $310,000 for the estimated costs to close down and exit our Australia operations. The reserve reflects the estimated cost to terminate our facility lease in Australia (with an original termination date of December 31, 2010), employee termination benefits and other liabilities associated with the wind-down and relocation of our operations in Australia. The facility lease agreement was terminated effective July 2009 and our operations in Australia have been relocated to Cambridge, U.K. and Palo Alto, California. We recorded actual expenses of approximately $9,000 and $236,000 in 2010 and 2009, respectively, against this reserve. We believe that the estimated remaining balance of approximately $61,000 in our reserve will be sufficient to cover any remaining exit costs.
         
    April 1 to  
    June 30,  
    2010  
Accrued wind-down reserve at March 31, 2010
  $ 70,000  
Less actual expenses recorded against estimated reserve during the period
    (3,000 )
Foreign currency translation
    (6,000 )
 
     
Accrued wind-down reserve at June 30, 2010
  $ 61,000  
 
     
Note 8. Commitments and Contingencies
Leases
     Capital Leases
     We entered into direct financing transactions with the State of Rhode Island and received proceeds from the issuance of industrial revenue bonds totaling $5,000,000 to finance the construction of our pilot manufacturing facility in Rhode Island. The related lease agreements are structured such that lease payments fully fund all semiannual interest payments and annual principal payments through maturity in August 2014. The interest rate for the remaining bond series is 9.5%. The bond contains certain restrictive covenants

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which limit, among other things, the payment of cash dividends and the sale of the related assets. The outstanding principal was approximately $783,000 at June 30, 2010 and $860,000 at December 31, 2009.
     Operating Leases
     We lease various real properties under operating leases that generally require us to pay taxes, insurance, maintenance, and minimum lease payments. Some of our leases have options to renew.
     Operating Leases — California
     We have leased an approximately 68,000 square foot facility located at the Stanford Research Park in Palo Alto, California. The facility includes space for animals, laboratories, offices, and a GMP (Good Manufacturing Practices) suite. Under the terms of the agreement, we were required to provide a letter of credit for a total of approximately $778,000, which serves as a security deposit for the duration of the lease term. The letter of credit issued by our financial institution is collateralized by a certificate of deposit for the same amount, which is reflected as restricted cash in other assets, non-current on our condensed consolidated balance sheets. In October 2009, we amended the lease to extend the expiry date of the lease term from March 31, 2010 to August 31, 2011. The aggregate rent payment for the extended lease term is approximately $3,100,000. The lease contains escalating rent payments, which we recognize as operating lease expense on a straight-line basis. Deferred rent was approximately $71,000 as of June 30, 2010 and $131,000 as of December 31, 2009, and is reflected as deferred rent on our accompanying condensed consolidated balance sheets. As of June 30, 2010, we had a space-sharing agreement covering approximately 10,451 square feet of this facility.
     Operating Leases — Rhode Island
     We entered into a fifteen-year lease agreement for a scientific and administrative facility in Rhode Island in connection with a sale and leaseback arrangement in 1997. The lease term expires June 30, 2013. The lease contains escalating rent payments, which we recognize on a straight-line basis. Deferred rent expense for this facility was approximately $758,000 at June 30, 2010 and $861,000 at December 31, 2009, and is included as part of the wind-down accrual on the accompanying condensed consolidated balance sheets.
     Operating Leases — United Kingdom
     On April 1, 2009, as part of our acquisition of the operations of SCS, we acquired operations in Cambridge, U.K. As of April 2009, our wholly-owned subsidiary, Stem Cell Sciences (UK) Ltd, had two lease agreements for approximately 3,900 square feet of office and lab space in aggregate in two buildings of the Babraham Research Campus in Cambridge, U.K. One of these two leases, for approximately 2,000 square feet, expired by its terms on February 28, 2010. The second, for approximately 1,900 square feet, has an initial term until March 2011, with an option, at our election, to extend the term for an additional five years. In February 2010, we entered into a new lease agreement effective March 1, 2010, for approximately 3,240 square feet. The initial term of this new lease will continue until March 2011, with an option, at our election, to extend the term for an additional two years. The two currently effective Cambridge leases cover in aggregate approximately 5,000 square feet. We expect to pay approximately 134,000 GBP as rental payments for 2010 in aggregate for the Cambridge leases. StemCells, Inc. is the guarantor of Stem Cell Sciences (UK) Ltd’s obligations under both leases.
Contingencies
     In July 2006, we filed suit against Neuralstem, Inc. in the Federal District Court for the District of Maryland, alleging that Neuralstem’s activities violate claims in four of the patents we exclusively licensed from NeuroSpheres. In December 2006, Neuralstem petitioned the U.S. Patent and Trademark Office (PTO) to reexamine two of the patents in our infringement action against Neuralstem, namely U.S. Patent No. 6,294,346 (claiming the use of human neural stem cells for drug screening) and U.S. Patent No. 7,101,709 (claiming the use of human neural stem cells for screening biological agents). In April 2007, Neuralstem petitioned the PTO to reexamine the remaining two patents in the suit, namely U.S. Patent No. 5,851,832 (claiming methods for proliferating human neural stem cells) and U.S. Patent No. 6,497,872 (claiming methods for transplanting human neural stem cells). These requests were granted by the PTO and, in June 2007, the parties voluntarily agreed to stay the pending litigation while the PTO considered these reexamination requests. In April 2008, the PTO upheld the ’832 and ’872 patents, as amended, and issued Notices of Intent to Issue an Ex Parte Reexamination Certificate for both. In May 2009, the PTO upheld the ’346 and ’709 patents, as amended, and issued Notices of Intent to Issue an Ex Parte Reexamination Certificate for both.
     In May 2008, we filed a second patent infringement suit against Neuralstem and its two founders, Karl Johe and Richard Garr. In this suit, which we filed in the Federal District Court for the Northern District of California, we allege that Neuralstem’s activities infringe claims in two patents we exclusively license from NeuroSpheres, specifically U.S. Patent No. 7,361,505 (claiming composition of matter of human neural stem cells derived from any source material) and U.S. Patent No. 7,115,418 (claiming methods for proliferating human neural stem cells). In addition, we allege various state law causes of action against Neuralstem arising out of

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its repeated derogatory statements to the public about our patent portfolio. Also in May 2008, Neuralstem filed suit against us and NeuroSpheres in the Federal District Court for the District of Maryland seeking a declaratory judgment that the ’505 and ’418 patents are either invalid or are not infringed by Neuralstem and that Neuralstem has not violated California state law. In August 2008, the California court transferred our lawsuit against Neuralstem to Maryland for resolution on the merits. In July 2009, the Maryland District Court granted our motion to consolidate these two cases with the litigation we initiated against Neuralstem in 2006. In August 2009, the Maryland District Court approved a scheduling order submitted by the parties for discovery and trial.
     Effective 2008, as part of an indemnification agreement with NeuroSpheres, we are entitled to offset all litigation costs incurred in this patent infringement suit, against amounts that would otherwise be owed to NeuroSpheres under our exclusive license agreements with NeuroSpheres, such as annual maintenance fees, milestones and royalty payments. We have capitalized $750,000 of our litigation costs because we will use these capitalized costs to offset the $50,000 royalty payment we are contractually obligated to pay NeuroSpheres each year. As the $50,000 annual payments are fully creditable against royalties due to Neurospheres, we have classified the $750,000 as prepaid royalties under “Other assets, non-current” on our accompanying condensed consolidated balance sheets. We have concluded that the estimated balance of $750,000 as of June 30, 2010 is a fair estimate and realizable against future milestone and royalty payments to NeuroSpheres, and that litigation costs incurred above this amount will be expensed as incurred. Management will reevaluate this estimate on a quarterly basis based on actual costs and other relevant factors.
Note 9. Warrant Liability
     We use the Black-Scholes option pricing model to estimate fair value of warrants issued. In using this model, we make certain assumptions about risk-free interest rates, dividend yields, volatility and expected term of the warrants. Risk-free interest rates are derived from the yield on U.S. Treasury debt securities. Dividend yields are based on our historical dividend payments, which have been zero to date. Volatility is derived from the historical volatility of our common stock as traded on Nasdaq. The expected term of the warrants is based on the time to expiration of the warrants from the date of measurement.
     In November 2008, we sold 13,793,104 units to institutional investors at a price of $1.45 per unit, for gross proceeds of $20,000,000. The units, each of which consisted of one share of common stock and a warrant to purchase 0.75 shares of common stock at an exercise price of $2.30 per share, were offered as a registered direct offering under a shelf registration statement previously filed with and declared effective by the SEC. We received total proceeds, net of offering expenses and placement agency fees, of approximately $18,637,000. We recorded the fair value of the warrants to purchase 10,344,828 shares of our common stock as a liability. The fair value of the warrant liability will be revalued at the end of each reporting period, with the change in fair value of the warrant liability recorded as a gain or loss in our condensed consolidated statements of operations. The fair value of the warrants will continue to be classified as a liability until such time as the warrants are exercised, expire or an amendment of the warrant agreement renders these warrants to be no longer classified as a liability.
     The assumptions used for the Black-Scholes option pricing model are as follows:
                 
    To Calculate  
    Fair Value of Warrant  
    Liability at  
    June 30, 2010     March 31, 2010  
Expected life (years)
    3.9       4.1  
Risk-free interest rate
    1.7 %     1.9 %
Expected volatility
    80.0 %     79.9 %
Expected dividend yield
    0 %     0 %
                         
    At June 30,     At March 31,     Change in Fair Value  
    2010     2010     of Warrant Liability  
Fair value of warrant liability
  $ 3,755,689     $ 5,441,379     $ (1,685,690 )
     In November 2009, we sold 10,000,000 units to institutional investors at a price of $1.25 per unit, for gross proceeds of $12,500,000. The units, each of which consisted of one share of common stock and a warrant to purchase 0.4 shares of common stock at an exercise price of $1.50 per share, were offered as a registered direct offering under a shelf registration statement previously filed with and declared effective by the SEC. We received total proceeds, net of offering expenses and placement agency fees, of approximately $11,985,000. We recorded the fair value of the warrants to purchase 4,000,000 shares of our common stock as a liability. The fair value of the warrant liability will be revalued at the end of each reporting period, with the change in fair value of the warrant liability recorded as a gain or loss in our condensed consolidated statements of operations. The fair value of the warrants will

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continue to be classified as a liability until such time as the warrants are exercised, expire or an amendment of the warrant agreement renders these warrants to be no longer classified as a liability.
     The assumptions used for the Black-Scholes option pricing model are as follows:
                 
    To Calculate  
    Fair Value of Warrant Liability at  
    June 30,     March 31,  
    2010     2010  
Expected life (years)
    4.8       5.1  
Risk-free interest rate
    2.1 %     2.4 %
Expected volatility
    76.2 %     76.7 %
Expected dividend yield
    0 %     0 %
                         
    At June 30,     At March 31,     Change in Fair Value  
    2010     2010     of Warrant Liability  
Fair value of warrant liability
  $ 1,964,560     $ 2,719,240     $ (754,680 )
Note 10. Common Stock
     On June 8, 2009, we filed a prospectus supplement that relates to the issuance and sale, from time to time, of up to $30,000,000 of our common stock. These sales will be made pursuant to the terms of a sales agreement with a sales agent. The prospectus is a part of a shelf registration statement that we filed with the SEC on June 25, 2008. Under this shelf registration process, we may offer to sell in one or more offerings equity or debt securities up to a total dollar amount of $100,000,000. Under our above mentioned sales agreement, in the six-month period ended June 30, 2010, we sold 1,192,200 shares of common stock at an average price of approximately $1.16 per share for gross proceeds of approximately $1,381,000.
     On June 29, 2010, we sold seven million shares of our common stock to an institutional investor, at a price of $0.865 per share. We received net proceeds, after deducting offering expenses and fees, of approximately $5,700,000. No warrants were issued in this transaction. As part of the sale agreement, the institutional investor has agreed to purchase an additional five million shares of common stock approximately 12 weeks after the initial sale, at a purchase price to be calculated using the then-current trading price, although we may elect not to sell the remaining shares. No warrants would be issued in connection with the sale of the additional shares to the institutional investor. The seven million shares were, and the additional five million shares would be, offered under our effective shelf registration statement previously filed with the SEC.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
     This report contains forward looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act that involve substantial risks and uncertainties. Such statements include, without limitation, all statements as to expectation or belief and statements as to our future results of operations; the progress of our research, product development and clinical programs; the need for, and timing of, additional capital and capital expenditures; partnering prospects; costs of manufacture of products; the protection of, and the need for, additional intellectual property rights; effects of regulations; the need for additional facilities; and potential market opportunities. Our actual results may vary materially from those contained in such forward-looking statements because of risks to which we are subject, including the fact that additional trials will be required to confirm the safety and demonstrate the efficacy of our HuCNS-SC cells for the treatment of neuronal ceroid lipofuscinosis (NCL, also known as Batten disease), Pelizeaus-Merzbacher disease (PMD), or any other disease; uncertainty as to whether the U.S. Food and Drug Administration (FDA) or other regulatory authorities will permit us to proceed with clinical testing of proposed products despite the novel and unproven nature of our technologies; the risk that our clinical trials or studies could be substantially delayed beyond their expected dates or cause us to incur substantial unanticipated costs; uncertainties in our ability to obtain the capital resources needed to continue our current research and development operations and to conduct the research, preclinical development and clinical trials necessary for regulatory approvals; the uncertainty regarding our ability to obtain a corporate partner or partners, if needed, to support the development and commercialization of our potential cell-based therapeutics products; the uncertainty regarding the outcome of our clinical trials or studies we may conduct in the future; the uncertainty regarding the validity and enforceability of our issued patents; the risk that we may not be able to manufacture additional master and working cell banks when needed; the uncertainty whether any products that may be generated in our cell-based therapeutics programs will prove clinically safe and effective; the uncertainty whether we will achieve significant revenue from product sales or become profitable; uncertainties regarding our obligations with respect to our former encapsulated cell therapy facilities in Rhode Island; obsolescence of our technologies; competition from third parties; intellectual property rights of third parties; litigation risks; and other risks to which we are subject. All forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements and risk factors set forth in “Risk Factors” in Part II, Item 1A of this report and Part I, Item 1A included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
Overview
The Company
     We are engaged in researching, developing, and commercializing stem cell therapeutics and technologies for stem cell-based research, drug discovery and development. Our research and development (R&D) efforts primarily support our cellular medicine programs, where we are engaged in identifying and developing potential cell-based therapeutics which can either restore or support organ function. In particular, since we relocated our corporate headquarters to California in 1999, our R&D efforts have been directed at refining our methods for identifying, isolating, culturing, and purifying the human neural stem cell and human liver engrafting cells (hLEC) and developing these as potential cell-based therapeutics for the central nervous system (CNS) and the liver, respectively. In our CNS Program, our HuCNS-SC® product candidate (purified human neural stem cells) is currently in clinical development for two indications: neuronal ceroid lipofuscinosis (NCL), a lysomal storage disorder often referred to as Batten disease, and Pelizeaus-Merzbacher Disease (PMD), a myelination disorder in the brain. We have completed a six patient Phase I clinical trial in infantile and late infantile NCL. The data from this trial showed that the HuCNS-SC cells were well tolerated and there was evidence of engraftment and long-term survival of the HuCNS-SC cells. In May 2010, we were authorized by the FDA to proceed to a second clinical trial in NCL, which is designed to further assess the safety of HuCNS-SC cells and to examine the ability of the cells to affect the progression of the disease. We anticipate this trial will be initiated in 2010, but there can be no assurance when or if such trial will be initiated. We are also currently conducting a Phase I clinical trial to assess the safety and preliminary effectiveness of HuCNS-SC cells as a treatment for PMD. We enrolled and treated the first patient in this trial in February 2010, and our goal is to complete enrollment by year end. In addition, our HuCNS-SC cells are in preclinical development for spinal cord injury and retinal disorders, and our goal is to initiate clinical testing in these indications in 2011 and 2012, respectively. In our Liver Program, we are in preclinical development with our human liver engrafting cells and are pursuing additional improvements to our process of isolating and purifying hLEC. We have also conducted research on several other cell types and in other areas, which could lead to other possible product candidates, process improvements or further research activities. For a brief description of our significant therapeutic research and development programs, see Overview “Research and Development Programs” in the Business Section of Part I, Item 1 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

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     We are also engaged in developing and commercializing applications of our technologies to enable stem cell-based research, which we believe represent nearer-term commercial opportunities. Our portfolio of technologies includes cell technologies relating to embryonic stem cells, induced pluripotent stem (iPS) cells, and tissue-derived (adult) stem cells; expertise and infrastructure for providing cell-based assays for drug discovery; a cell culture products business; and an intellectual property portfolio with claims relevant to cell processing, reprogramming and manipulation, as well as to gene targeting and insertion. Many of our enabling technologies were acquired in April 2009 as part of our acquisition of the operations of Stem Cell Sciences Plc (SCS). See Note 4, “Acquisition of SCS Operations,” in the Notes to Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for further information.
     We have not derived any revenue or cash flows from the sale or commercialization of any products except for license revenue for certain of our patented cells and revenue from the sale of proprietary cell culture products for use in research. As a result, we have incurred annual operating losses since inception and expect to incur substantial operating losses in the future. Therefore, we are dependent upon external financing from equity and debt offerings and revenue from collaborative research arrangements with corporate sponsors to finance our operations. We have no such collaborative research arrangements at this time and there can be no assurance that such financing or partnering revenue will be available when needed or on terms acceptable to us.
     Before we can derive revenue or cash inflows from the commercialization of any of our therapeutic product candidates, we will need to: (i) conduct substantial in vitro testing and characterization of our proprietary cell types, (ii) undertake preclinical and clinical testing for specific disease indications; (iii) develop, validate and scale-up manufacturing processes to produce these cell-based therapeutics, and (iv) obtain required regulatory approvals. These steps are risky, expensive and time consuming.
     Overall, we expect our R&D expenses to be substantial and to increase for the foreseeable future as we continue the development and clinical investigation of our current and future product candidates. However, expenditures on R&D programs are subject to many uncertainties, including whether we develop our product candidates with a partner or independently. We cannot forecast with any degree of certainty which of our current product candidates will be subject to future collaboration, when such collaboration agreements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements. In addition, there are numerous factors associated with the successful commercialization of any of our cell-based therapeutics, including future trial design and regulatory requirements, many of which cannot be determined with accuracy at this time given the stage of our development and the novel nature of stem cell technologies. The regulatory pathways, both in the United States and internationally, are complex and fluid given the novel and, in general, clinically unproven nature of stem cell technologies. At this time, due to such uncertainties and inherent risks, we cannot estimate in a meaningful way the duration of, or the costs to complete, our R&D programs or whether, when or to what extent we will generate revenues or cash inflows from the commercialization and sale of any of our therapeutic product candidates. While we are currently focused on advancing each of our product development programs, our future R&D expenses will depend on the determinations we make as to the scientific and clinical prospects of each product candidate, as well as our ongoing assessment of the regulatory requirements and each product candidate’s commercial potential.
     Given the early stage of development of our therapeutic product candidates, any estimates of when we may be able to commercialize one or more of these products would not be meaningful. Moreover, any estimate of the time and investment required to develop potential products based upon our proprietary HuCNS-SC and hLEC technologies will change depending on the ultimate approach or approaches we take to pursue them, the results of preclinical and clinical studies, and the content and timing of decisions made by the FDA and other regulatory authorities. There can be no assurance that we will be able to develop any product successfully, or that we will be able to recover our development costs, whether upon commercialization of a developed product or otherwise. We cannot provide assurance that any of these programs will result in products that can be marketed or marketed profitably. If certain of our development-stage programs do not result in commercially viable products, our results of operations could be materially adversely affected.
     The research markets served by our enabling technologies are highly competitive, complex and dynamic. Technological advances and scientific discoveries have accelerated the pace of change in biological research, and stem cell technologies have been evolving particularly fast. We compete mainly by focusing on specialty cell culture products and cell-based assays, which are custom designed for use in stem cell-based research, where we believe our expertise, intellectual property and reputation give us competitive advantage. We believe that, in this particular market niche, our products and technologies offer customers specific advantages over those offered by our competitors. We compete by offering innovative, quality-controlled products, consistently made and designed to produce reproducible results. We continue to make investments in research and development, quality management, quality improvement, and product innovation. There can be no assurance that we will have sufficient resources to continue to make such investments. For the

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six-month period ended June 30, 2010, we generated revenues from the sale of specialty cell culture products of approximately $189,000. There can be no assurance that we will be able to continue to generate such revenues in the future.
Significant Events
     In May 2010, we appointed R. Scott Greer to our Board of Directors. Mr. Greer is a successful entrepreneur with a proven track record in developing and growing life sciences companies, and adds more than twenty-five years of life sciences and financial services industry experience to our Board. In addition, we reconstituted the Strategic Transactions Committee as a standing committee of the Board. The Strategic Transactions Committee, which Mr. Greer chairs, is intended to provide guidance and consultation to management and advice to the full Board on various corporate initiatives.
     In May 2010, we were authorized by the FDA to proceed to a second clinical trial in NCL. This trial is designed to further assess the safety of HuCNS-SC cells in NCL, while also examining the ability of the cells to affect the progression of the disease. We anticipate this trial will be initiated in 2010.
     In May 2010, the co-principal investigator of our Phase I NCL trial, Nathan Selden, M.D., Ph.D., F.A.C.S., F.A.A.P., gave a feature presentation at the American Association of Neurological Surgeons 2010 Annual Meeting, one of the leading forums for neurosurgeons from around the world to present and discuss cutting-edge research in the field. In his presentation, Dr. Selden summarized the positive safety data from the trial and presented new data from the ongoing long-term observational study which continue to affirm the safety profile of the HuCNS-SC cells.
     In June 2010, we announced that newly published independent research demonstrates that our GS2-M™ cell culture media formulation enhances the pluripotency of human embryonic stem (ES) and induced pluripotent stem (iPS) cells. Our GS2-M medium has already been shown to enable the derivation and long-term maintenance of mouse iPS cells. With this new application of GS2-M, researchers may now be able to significantly advance human pluripotent stem cell research.
     In June 2010, three of our scientists made presentations at the International Society for Stem Cell Research (ISSCR) 8th Annual Meeting, which is the preeminent meeting of stem cell experts from public, private, academic, and government institutions from around the world. These presentations highlight our scientific leadership and progress in advancing discoveries to potential commercial applications.
     In June 2010, we sold seven million shares of our common stock to an institutional investor, at a price of $0.865 per share. We received net proceeds, after deducting offering expenses and fees, of approximately $5,700,000. No warrants were issued in this transaction. As part of the sale agreement, the institutional investor has agreed to purchase an additional five million shares of common stock approximately 12 weeks after the initial sale, at a purchase price to be calculated using the then-current trading price, although we may elect not to sell the additional shares. No warrants would be issued in connection with the sale of the additional shares. The seven million shares were, and the additional five million shares would be, offered under our effective shelf registration statement previously filed with the SEC.
Critical Accounting Policies and the Use of Estimates
     The accompanying discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements and the related disclosures, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires management to make estimates, assumptions, and judgments that affect the reported amounts in our condensed consolidated financial statements and accompanying notes. These estimates form the basis for making judgments about the carrying values of assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, and we have established internal controls related to the preparation of these estimates. Actual results and the timing of the results could differ materially from these estimates.
Stock-Based Compensation
     U.S. GAAP requires us to recognize expense related to the fair value of our stock-based payment awards, including employee stock options and restricted stock units. Under the provisions of U.S. GAAP, employee stock-based payment is estimated at the date of grant based on the award’s fair value using the Black-Scholes-Merton (Black-Scholes) option-pricing model and is recognized as expense ratably over the requisite service period. The Black-Scholes option-pricing model requires the use of certain assumptions, the most significant of which are our estimates of the expected volatility of the market price of our stock and the expected term of the

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award. Our estimate of the expected volatility is based on historical volatility. The expected term represents our estimated period during which our stock-based awards remain outstanding. We estimate the expected term based on historical experience of similar awards, giving consideration to the contractual terms of the awards, vesting requirements, and expectation of future employee behavior, including post-vesting terminations.
     We review our valuation assumptions at each grant date and, as a result, our assumptions in future periods may change. As of June 30, 2010,we expect to recognize approximately $8,803,000 of compensation expense related to unvested stock-based awards over a weighted-average period of 2.9 years. See also Note 6, “Stock-Based Compensation,” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
Wind-down expenses — Rhode Island
     In connection with exiting our research and manufacturing operations in Lincoln, Rhode Island, and the relocation of our corporate headquarters and remaining research laboratories to California in October 1999, we provided a reserve for our estimate of the exit cost obligation. The reserve reflects estimates of the ongoing costs of our former scientific and administrative facility in Lincoln, which we hold on a lease that terminates on June 30, 2013. We are seeking to sublease, assign, sell, or otherwise divest ourselves of our interest in the facility at the earliest possible time, but we cannot determine with certainty a fixed date by which such events will occur, if at all.
     In determining the facility exit cost reserve amount, we are required to consider our lease payments through to the end of the lease term and estimate other relevant factors such as facility operating expenses, real estate market conditions in Rhode Island for similar facilities, occupancy rates, and sublease rental rates projected over the course of the leasehold. We re-evaluate the estimate each quarter, taking account of changes, if any, in each underlying factor. The process is inherently subjective because it involves projections over time — from the date of the estimate through the end of the lease — and it is not possible to determine any of the factors, except the lease payments, with certainty over that period.
     Management forms its best estimate on a quarterly basis, after considering actual sublease activity, reports from our broker/realtor about current and predicted real estate market conditions in Rhode Island, the likelihood of new subleases in the foreseeable future for the specific facility and significant changes in the actual or projected operating expenses of the property. We discount the projected net outflow over the term of the leasehold to arrive at the present value, and adjust the reserve to that figure. The estimated vacancy rate for the facility is an important assumption in determining the reserve because changes in this assumption have the greatest effect on estimated sublease income. In addition, the vacancy rate estimate is the variable most subject to change, while at the same time it involves the greatest judgment and uncertainty due to the absence of highly predictive information concerning the future of the local economy and future demand for specialized laboratory and office space in that area. The average vacancy rate of the facility over the last seven years (2003 through 2009) was approximately 74%, varying from 62% to 89%. As of June 30, 2010, based on current information available to management, the vacancy rate is projected to be approximately 76% for 2010 and approximately 70% from 2011 through the end of the lease. These estimates are based on actual occupancy as of June 30, 2010, predicted lead time for acquiring new subtenants, historical vacancy rates for the area, and assessments by our broker/realtor of future real estate market conditions. If the assumed vacancy rate for the remainder of the lease had been 5% higher or lower at June 30, 2010, then the reserve would have increased or decreased by approximately $117,000. Similarly, a 5% increase or decrease in the operating expenses for the facility would have increased or decreased the reserve by approximately $83,000, and a 5% increase or decrease in the assumed average rental charge per square foot would have increased or decreased the reserve by approximately $35,000. Management does not wait for specific events to change its estimate, but instead uses its best efforts to anticipate them on a quarterly basis. See Note 7 “Wind-Down Expenses,” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
Wind-down expenses — Australia
     On April 1, 2009, as part of our acquisition of the SCS operations, we acquired operations near Melbourne, Australia. In order to reduce operating complexity and expenses, we made the decision to close our site in Australia and consolidate personnel and programs to our Cambridge, U.K. and Palo Alto, California sites. U.S. GAAP requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. In accordance with U.S. GAAP requirements, at June 30, 2009, we established a short-term reserve of approximately $310,000 for the estimated costs to close down and exit our Australia operations. The reserve reflects the estimated cost for an early termination of our facility lease in Australia (with an original termination date of December 31, 2010), employee termination benefits and other liabilities associated with the wind-down and relocation of our operations in Australia. The facility lease agreement has been terminated and our operations in Australia have been relocated to Cambridge, U.K. and Palo Alto, California. We recorded actual expenses of approximately $6,000 and $236,000 against this reserve

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in 2010 and 2009, respectively. As of June 30, 2010, we believe that the estimated remaining balance of approximately $61,000 in our reserve will be sufficient to cover any remaining exit costs.
Business Combinations
     The operating results of acquired companies or operations are included in our consolidated financial statements starting on the date of acquisition. Goodwill is recorded at the time of an acquisition and is calculated as the difference between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. Accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including in-process research and development. Goodwill and intangible assets deemed to have indefinite lives are not amortized but are subject to annual impairment tests. If the assumptions and estimates used to allocate the purchase price are not correct, or if business conditions change, purchase price adjustments or future asset impairment charges could be required. We test goodwill for impairment on an annual basis or more frequently if we believe indicators of impairment exist. Impairment evaluations involve management estimates of asset useful lives and future cash flows. Significant management judgment is required in the forecasts of future operating results that are used in the evaluations. It is possible, however, that the plans and estimates used may be incorrect. If our actual results, or the plans and estimates used in future impairment analysis, are lower than the original estimates used to assess the recoverability of these assets, we could incur impairment charges in a future period.
Results of Operations
     Our results of operations have varied significantly from year to year and quarter to quarter and may vary significantly in the future due to the occurrence of material recurring and nonrecurring events, including without limitation the receipt and payment of recurring and nonrecurring licensing payments, the initiation or termination of clinical studies, research collaborations and development programs for both cell-based therapeutic products and research tools, unpredictable or unanticipated manufacturing and supply costs, unanticipated capital expenditures necessary to support our business, expenses arising out of the integration of the acquired SCS operations, developments in on-going patent protection and litigation, the on-going expenses to lease and maintain our Rhode Island facilities, and the increasing costs associated with operating our California and Cambridge, U.K. facilities.
     We acquired the operations of SCS on April 1, 2009, and have consolidated such operations since that date (See Note 4. “Acquisition of Stem Cell Sciences Plc (SCS) Operations,” in the notes to condensed consolidated financial statements of Part I, Item1 of this Form 10-Q for further information). Consequently, our results of operations for the six-month period ended June 30, 2010 will include the acquired operations for the full six months, but will only include them in the second quarter of 2009 for the six-month period in 2009.
Revenue and Cost of Product Sales
     Revenue for the three and six-month periods ended June 30, 2010, as compared with the same periods in 2009, is summarized in the table below:
                                                                 
    Three months ended,                     Six months ended,        
    June 30     Change in 2010 versus 2009     June 30     Change in 2010 versus 2009  
    2010     2009     $     %     2010     2009     $     %  
Revenue:
                                                               
Licensing agreements and grants
  $ 171,550     $ 144,851     $ 26,699       18 %   $ 285,399     $ 201,453     $ 83,946       42 %
Product sales
    72,581       120,600       (48,019 )     (40 %)     189,005       120,600       68,405       57 %
 
                                               
Total revenue
    244,131       265,451       (21,320 )     (8 %)     474,404       322,053       152,351       47 %
 
                                               
Cost of product sales
    24,862       59,525       34,663       (58 %)     68,624       59,525       (9,099 )     15 %
 
                                               
Gross Profit
  $ 219,269     $ 205,926     $ 13,343       6 %   $ 405,780     $ 262,528     $ 143,252       55 %
 
                                               
     Total revenue in the second quarter of 2010 was approximately $244,000, which was 8% lower than total revenue of approximately $265,000 in the second quarter of 2009. The decrease in 2010 compared to 2009 was primarily attributable to a decrease in product sales in the second quarter of 2010 compared to the same period in 2009.
     Second quarter ended June 30, 2010 versus second quarter ended June 30, 2009. Licensing and grant revenue for the second quarter of 2010 was approximately $27,000, or 18%, higher as compared to the same period in 2009. Approximately $18,000 of this increase was primarily attributable to receipt of up front non-refundable license fees, and approximately $9,000 of the increase was from an existing grant which we were awarded in October 2008 from the National Institute of Diabetes and Digestive and Kidney Diseases to research and develop a potential cell-based therapeutic for liver disease. In the second quarter of 2010, revenue from product sales was approximately $48,000, or 40%, lower as compared to the same period in 2009. This decrease was primarily

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attributable to several large orders for product in the second quarter of 2009 that were not repeated in the second quarter of 2010, as well as the effects of depreciation of the British pound relative to the U.S. dollar.
     Total revenue in the six-month period ended June 30, 2010 was approximately $474,000, which was 47% higher than total revenue of approximately $322,000 in the similar period of 2009. The six-month period of 2010 includes two quarters of revenue recognized and consolidated in connection with our acquired operations, as compared to one quarter for the same period in 2009.
     Six-month period ended June 30, 2010 versus six-month period ended June 30, 2009. Licensing and grant revenue for the six-month period ended June 30, 2010, was approximately $84,000, or 42%, higher compared to the same period in 2009. This increase was primarily attributable to approximately $72,000 in grant and licensing revenue recognized and consolidated in connection with our acquired operations, and an increase of approximately $21,000 in licensing revenue. These increases were offset by a decrease in revenue of approximately $9,000 from an existing grant which we were awarded in October 2008 from the National Institute of Diabetes and Digestive and Kidney Diseases to research and develop a potential cell-based therapeutic for liver disease. In the six-month period ended June 30, 2010, we recognized approximately $189,000 as revenue from product sales and $69,000 as cost of product sales, compared to approximately $121,000 as revenue from product sales and $60,000 as cost of products sales, for the same period in 2009. The increase in the first six months of 2010 compared to the similar period in 2009 was primarily attributable to the consolidation of two quarters of product sales from our acquired operations in the U.K. in the six-month period of 2010 compared to one quarter for the same period in 2009.
Operating Expenses
     Operating expenses for the three and six-month periods ended June 30, 2010, as compared with the same periods in 2009, are summarized in the table below:
                                                                 
    Three months ended,     Change in 2010 versus     Six months ended,     Change in 2010 versus  
    June 30     2009     June 30     2009  
    2010     2009     $     %     2010     2009     $     %  
Operating expenses:
                                                               
Research & development
  $ 4,858,228     $ 5,054,600     $ (196,372 )     (4 )%   $ 9,895,742     $ 9,290,389     $ 605,353       7 %
Selling, general & administrative
    2,286,678       2,201,974       84,704       4 %     4,871,420       4,740,886       130,534       3 %
Wind-down expenses
    125,833       340,064       (214,231 )     (63 )%     291,168       545,500       (254,332 )     (47 )%
 
                                               
Total operating expenses
  $ 7,270,739     $ 7,596,638     $ (325,899 )     (4 )%   $ 15,058,330     $ 14,576,775     $ 481,555       3 %
 
                                               
     Research and Development Expenses
     Our R&D expenses consist primarily of salaries and related personnel expenses, costs associated with clinical trials and regulatory submissions; costs associated with preclinical activities such as toxicology studies; costs associated with cell processing and process development; certain patent-related costs such as licensing; facilities related costs such as depreciation; lab equipment and supplies. Clinical trial expenses include payments to vendors such as clinical research organizations, contract manufacturers, clinical trial sites, laboratories for testing clinical samples and consultants. Cumulative R&D costs incurred since we refocused our activities on developing cell-based therapeutics (fiscal years 2000 through the three months ended June 30, 2010) were approximately $121 million. Over this period, the majority of these cumulative costs were related to: (i) characterization of our proprietary HuCNS-SC cells, (ii) expenditures for toxicology and other preclinical studies, preparation and submission of applications to regulatory agencies to conduct clinical trials and obtaining regulatory clearance to initiate such trials, all with respect to our HuCNS-SC cells, (iii) preclinical studies and development of our human liver engrafting cells, (iv) costs associated with cell processing and process development and (v) costs associated with our clinical studies.
     We use and manage our R&D resources, including our employees and facilities, across various projects rather than on a project-by-project basis for the following reasons. The allocations of time and resources change as the needs and priorities of individual projects and programs change, and many of our researchers are assigned to more than one project at any given time. Furthermore, we are exploring multiple possible uses for each of our proprietary cell types, so much of our R&D effort is complementary to and supportive of each of these projects. Lastly, much of our R&D effort is focused on manufacturing processes, which can result in process improvements useful across cell types. We also use external service providers to assist in the conduct of our clinical trials, to

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manufacture certain of our product candidates and to provide various other R&D related products and services. Many of these costs and expenses are complementary to and supportive of each of our programs. Because we do not have a development collaborator for any of our product programs, we are currently responsible for all costs incurred with respect to our product candidates.
     R&D expenses totaled approximately $4,858,000 in the second quarter of 2010 compared with $5,055,000 in the second quarter of 2009.
     Second quarter ended June 30, 2010 versus second quarter ended June 30, 2009. The decrease of approximately $196,000, or 4%, from 2009 to 2010 was primarily attributable to (i) decreased R&D expenses of approximately $97,000 primarily attributable to consolidating our operations, including the wind-down of our Australian operations and consolidating those programs with our U.K. and U.S. operations, (ii) a decrease in allocated facilities and information technology expenses to R&D of approximately $97,000 attributable to lower operating costs, and (iii) a decrease in net other operating expenses of approximately $2,000.
     R&D expenses totaled approximately $9,896,000 in the six-month period ended June 30, 2010, compared with $9,290,000 for the same period in 2009.
     Six-month period ended June 30, 2010 versus six-month period ended June 30, 2009. The increase of approximately $606,000, or 7%, from 2009 to 2010 was primarily attributable to (i) an approximately $469,000 increase in R&D expenses related to consolidation of two quarters of our acquired operations in the U.K. in the six-month period of 2010 compared to one quarter for the same period in 2009; (ii) an increase in external services of approximately $175,000 primarily related to our phase I clinical trial to assess the safety and preliminary effectiveness of HuCNS-SC cells as a treatment for PMD, and (iii) a net increase in personnel expenses of approximately $22,000 resulting from an increased head count at our California site to support expanded operations in our cell processing and product development programs. These increased expenses were partially offset by a decrease in other expenses of approximately $60,000.
     Selling, General and Administrative Expenses
     Selling, general and administrative (SG&A) expenses are primarily comprised of salaries, benefits and other staff related costs associated with sales and marketing, finance, legal, human resources, information technology, and other administrative personnel, facilities and overhead costs, external legal and other external general and administrative services.
     SG&A expenses totaled approximately $2,287,000 in the second quarter of 2010 compared with approximately $2,202,000 in the second quarter of 2009.
     Second quarter ended June 30, 2010 versus second quarter ended June 30, 2009. The increase of approximately $85,000, or 4%, in SG&A expenses from 2009 to 2010 was primarily attributable to (i) increased external service expenses of approximately $179,000, primarily legal fees for our litigation against Neuralstem (see also Note 8, “Commitments and Contingencies,” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information), and (ii) an increase of approximately $10,000 in other expenses. These increased expenses were partially offset by a decrease in stock-based compensation expense of approximately $104,000.
     SG&A expenses totaled approximately $4,871,000 in the six-month period ended June 30, 2010, compared with $4,741,000 for the same period in 2009.
     Six-month period ended June 30, 2010 versus six-month period ended June 30, 2009. The increase of approximately $130,000, or 3%, in SG&A expenses from 2009 to 2010 was primarily attributable to (i) an increase of approximately $224,000 in SG&A expense related to consolidation of acquired operations for two quarters in the six-month period in 2010 compared to one quarter for the same period in 2009, (ii) an increase in external services of approximately $40,000, mainly due to an increase in recruiting and investor relations expenses, and (iii) an increase of approximately $26,000 in other expenses. These increased expenses were partially offset by a decrease in personnel expenses of approximately $160,000, primarily attributable to lower stock-based compensation expense.
Wind-down Expenses
                                 
    Three months ended,     Six months ended,  
    June 30     June 30  
    2010     2009     2010     2009  
Rhode Island
  $ 125,833     $ 29,795     $ 291,168     $ 235,231  
Australia
          310,269             310,269  
 
                       
Total wind-down expenses
  $ 125,833     $ 340,064     $ 291,168     $ 545,500  
 
                       

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     Rhode Island
     In 1999, in connection with exiting our former research facility in Rhode Island, we created a reserve for the estimated lease payments and operating expenses related to it. The reserve has been re-evaluated and adjusted based on assumptions relevant to real estate market conditions and the estimated time until we could either fully sublease, assign or sell our remaining interests in the property. The reserve was approximately $4,433,000 at December 31, 2009. Payments net of subtenant income of approximately $280,000 for the second quarter and $595,000 for the six-month period ended June 30, 2010, were recorded against this reserve. At June 30, 2010, we re-evaluated the estimate and adjusted the reserve to approximately $4,026,000 by recording additional wind-down expenses of approximately $126,000 in the second quarter of 2010, for a total of approximately $291,000 for the six-month period ended June 30, 2010. For the similar period in 2009, payments recorded against the reserve were approximately $293,000 in the second quarter of 2009, and $624,000 for the six-month period ended June 30, 2009, and additional expenses recorded to adjust the reserve were approximately $30,000 in the second quarter of 2009, for a total of approximately $235,000 for the six-month period ended June 30, 2009. Expenses for this facility will fluctuate based on changes in tenant occupancy rates and other operating expenses related to the lease. Even though it is our intent to sublease, assign, sell, or otherwise divest ourselves of our interests in the facility at the earliest possible time, we cannot determine with certainty a fixed date by which such events will occur. In light of this uncertainty, based on estimates, we will periodically re-evaluate and adjust the reserve, as necessary. See Note 7 “Wind-down expenses,” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
     Australia
     On April 1, 2009, as part of our acquisition of the SCS operations, we acquired operations near Melbourne, Australia. In order to reduce operating complexity and expenses, we made the decision to close our site in Australia and consolidate personnel and programs to our Cambridge, U.K. and Palo Alto, California sites. U.S. GAAP requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. In accordance with U.S. GAAP requirements, at June 30, 2009, we established a short-term reserve of approximately $310,000 for the estimated costs to close down and exit our Australia operations. The reserve reflects the estimated cost to terminate our facility lease in Australia (with an original termination date of December 31, 2010), employee termination benefits and other liabilities associated with the wind-down and relocation of our operations in Australia. The facility lease agreement has been terminated and our operations in Australia have been relocated to Cambridge, U.K. and Palo Alto, California. We recorded actual expenses of approximately $9,000 and $236,000 against this reserve in 2010 and 2009 respectively. No further adjustments were made to the reserve balance as we believe that the estimated remaining balance of approximately $61,000 in our reserve at June 30, 2010, will be sufficient to cover any remaining exit costs.
Other Income (Expense)
     Other income totaled approximately $2,441,000 in the second quarter of 2010 compared with other income of $24,000 in the same period of 2009, and other income of $3,918,000 for the six-month period ended June 30, 2010 compared with other expense of approximately $2,334,000 for the six-month period ended June 30, 2009.
                                                                 
    Three months ended,     Change in 2010 versus     Six months ended,     Change in 2010 versus  
    June 30     2009     June 30     2009  
    2010     2009     $     %     2010     2009     $     %  
Other income (expense):
                                                               
Gain on sale of marketable securities
  $     $     $           $     $ 397,866     $ (397,866 )     *  
Change in fair value of warrant liability
    2,440,370       102,517       2,337,853       2,280 %     3,956,719       (2,652,931 )     6,609,650       (249 )%
Interest income
    13,309       8,338       4,971       60 %     13,903       50,285       (36,382 )     (72 )%
Interest expense
    (25,054 )     (29,074 )     4,020       (14 )%     (50,554 )     (57,250 )     6,696       (12 )%
Other income (expense), net
    12,498       (57,424 )     69,922       (122 )%     (1,940 )     (71,634 )     69,694       (97 )%
 
                                                   
Total other income
  $ 2,441,123     $ 24,357     $ 2,416,766       9,922 %   $ 3,918,128     $ (2,333,664 )   $ 6,251,792       (268 )%
 
                                                   
 
*   Calculation is not meaningful.
Gain on Sale of Marketable Equity Securities

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     In the first quarter of 2009, we sold in aggregate 2,900,000 shares of ReNeuron and received proceeds of approximately $510,000. We recognized a realized gain of approximately $398,000 for that quarter. We did not sell any ReNeuron shares during the six-month period ended June 30, 2010. We owned 1,921,924 ordinary shares of ReNeuron at June 30, 2010. See Note 2 “Financial Instruments” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
     Change in Fair Value of Warrant Liability
     As part of both our November 2008 and November 2009 financings, we issued warrants with five year terms to purchase 10,344,828 and 4,000,000 shares of our common stock at $2.30 and $1.50 per share, respectively. As the contracts include the possibility of net-cash settlement, we are required to classify the fair value of the warrants issued as a liability, with subsequent changes in fair value to be recorded as income (loss) on change in fair value of warrant liability. The fair value of the warrants is determined using the Black-Scholes option pricing model and is affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. Our estimate of the expected volatility is based on historical volatility. The expected term of the warrants is based on the time to expiration of the warrants from the date of measurement. Risk-free interest rates are derived from the yield on U.S. Treasury debt securities. We will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expire or are amended in a way that would no longer require these warrants to be classified as a liability. See Note 9 “Warrant Liability” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
     Interest Income
     Interest income in the second quarter of 2010 was relatively flat when compared to the same period in 2009. Interest income for the six-month period ended June 30, 2010 decreased by approximately $36,000, or 72%, when compared to the same period in 2009. The decrease was primarily due to a lower average yield in 2010.
     Interest Expense
     Interest expense for the second quarter of 2010, and for the six-month period ended June 30, 2010, was relatively flat when compared to the similar period in 2009. Interest expense is primarily for outstanding debt and capital lease balances. See Note 8 “Commitment and Contingencies,” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
Liquidity and Capital Resources
     Since our inception, we have financed our operations through the sale of common and preferred stock, the issuance of long-term debt and capitalized lease obligations, revenue from collaborative agreements, research grants, license fees, and interest income.
                                 
    June 30,     December 31,     Change        
    2010     2009     $     %  
Cash and cash equivalents
  $ 30,765,504     $ 38,617,977     $ (7,852,473 )     (20 )%
     In summary, our cash flows were:
                                 
    Six months ended June 30,     Change in 2010 versus 2009  
    2010     2009     $     %  
Net cash used in operating activities
  $ (13,746,173 )   $ (12,382,824 )   $ (1,363,349 )     11 %
Net cash provided by (used in) investing activities
  $ (509,064 )   $ 4,038,189     $ (4,547,253 )     (113 )%
Net cash provided by financing activities
  $ 6,443,669     $ 15,208,452     $ (8,764,783 )     (58 )%
Net Cash Used in Operating Activities
     Net cash used in operating activities in the first six months of 2010 increased by approximately $1,363,000, or 11%, when compared to the same period of 2009. Cash used in operating activities is primarily driven by our net loss as adjusted for non-cash charges and differences in the timing of cash flows.

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Net Cash Provided by (Used in) Investing Activities
     The decrease of approximately $4,547,000, or 113%, from 2009 to 2010 for net cash provided by investing activities, was primarily attributable to a higher number of marketable debt securities maturing in the first six months of 2009 as compared to the similar period in 2010 and the sale of 2,900,000 shares of ReNeuron for net proceeds of approximately $510,000 in the first quarter of 2009.
Net Cash Provided by Financing Activities
     Net cash provided by financing activities in the first six months of 2010 decreased approximately $8,765,000, or 58%, compared to the same period in 2009 primarily due to lower net proceeds from sales of common stock. In the first six months of 2010, we received aggregate net proceeds of approximately $7,015,000 from the sale of 1,192,200 shares of common stock at an average price of $1.16 per share under sales agreements with a sales agent and the sale of 7,000,000 shares of common stock at $0.865 per share to an institutional investor. In the same period of 2009, we received net proceeds of approximately $15,000,000 from the sale of 8,262,400 shares of common stock at an average price of $1.89 per share under sales agreements with a sales agent. See Note 10 “Common Stock” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information on the financing activities in 2010.
     Listed below are key financing transactions entered into by us in the prior three years:
    In November 2009, we sold 10,000,000 units to institutional investors at a price of $1.25 per unit, for gross proceeds of $12,500,000. The units, each of which consisted of one share of common stock and a warrant to purchase 0.4 shares of common stock at an exercise price of $1.50 per share, were offered as a registered direct offering under a shelf registration statement previously filed with and declared effective by the Securities and Exchange Commission. We received total proceeds net of offering expenses and placement agency fees of approximately $11,985,000.
 
    In June 2009, we filed a prospectus supplement that relates to the issuance and sale of up to $30,000,000 of our common stock, from time to time through a sales agreement with a sales agent. The prospectus is a part of a shelf registration statement that we filed with the SEC on June 25, 2008. Under this shelf registration process, we may offer to sell in one or more offerings equity or debt securities up to a total dollar amount of $100,000,000. In 2009, we sold a total of 1,830,000 shares of our common stock under a June 2009 sales agreement with a sales agent at an average price per share of $1.80 for gross proceeds of approximately $3,291,000.
 
    In November 2008, we sold 13,793,104 units to institutional investors at a price of $1.45 per unit, for gross proceeds of $20,000,000. The units, each of which consisted of one share of common stock and a warrant to purchase 0.75 shares of common stock at an exercise price of $2.30 per share, were offered as a registered direct offering under a shelf registration statement previously filed with and declared effective by the Securities and Exchange Commission. We received total proceeds net of offering expenses and placement agency fees of approximately $18,637,000.
 
    In 2007, 2008 and 2009, we sold a total of 10,000,000 shares of our common stock at an average price per share of $2.06 for gross proceeds of approximately $20,555,000. These shares were sold under a sales agreement entered into in December 2006, under which up to 10,000,000 shares may be sold from time to time under a shelf registration statement.
     We have incurred significant operating losses and negative cash flows since inception. We have not achieved profitability and may not be able to realize sufficient revenue to achieve or sustain profitability in the future. We do not expect to be profitable in the next several years, but rather expect to incur additional operating losses. We have limited liquidity and capital resources and must obtain significant additional capital resources in order to sustain our product development efforts, for acquisition of technologies and intellectual property rights, for preclinical and clinical testing of our anticipated products, pursuit of regulatory approvals, acquisition of capital equipment, laboratory and office facilities, establishment of production capabilities, for selling, general and administrative expenses and other working capital requirements. We rely on cash balances and proceeds from equity and debt offerings, proceeds from the transfer or sale of our intellectual property rights, equipment, facilities or investments, and government grants and funding from collaborative arrangements, if obtainable, to fund our operations.
     We intend to pursue opportunities to obtain additional financing in the future through equity and debt financings, grants and collaborative research arrangements. On June 25, 2008 we filed with the SEC a universal shelf registration statement, declared effective July 18, 2008, which permits us to issue up to $100 million worth of registered debt and equity securities. Under this effective shelf registration, we have the flexibility to issue registered securities, from time to time, in one or more separate offerings or other transactions with the size, price and terms to be determined at the time of issuance. Registered securities issued using this shelf may be used to raise additional capital to fund our working capital and other corporate needs, for future acquisitions of assets, programs or businesses, and for other corporate purposes. As of August 5, 2010, we had approximately $41 million under our

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universal shelf registration statement available for issuing debt or equity securities; approximately $30 million of this $41 million has been reserved for the potential exercise of the warrants issued in connection with our November 2008 and November 2009 financings.
     The source, timing and availability of any future financing will depend principally upon market conditions, interest rates and, more specifically, on our progress in our exploratory, preclinical and future clinical development programs. Funding may not be available when needed — at all, or on terms acceptable to us. Lack of necessary funds may require us, among other things, to delay, scale back or eliminate some or all of our research and product development programs, planned clinical trials, and/or our capital expenditures or to license our potential products or technologies to third parties. In addition, the decline in economic activity, together with the deterioration of the credit and capital markets, could have an adverse impact on potential sources of future financing.
Commitments
     See Note 8, “Commitments and Contingencies” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
Off-Balance Sheet Arrangements
     We have certain contractual arrangements that create potential risk for us and are not recognized in our Consolidated Balance Sheets. Discussed below are those off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.
     Operating Leases
     We lease various real properties under operating leases that generally require us to pay taxes, insurance, maintenance, and minimum lease payments. Some of our leases have options to renew.
     Operating Leases — California
     We entered into and amended a lease agreement for an approximately 68,000 square foot facility located at the Stanford Research Park in Palo Alto, California. At June 30, 2010, we expect to pay in aggregate, approximately $1,748,000 in rent and estimated operating expenses for the remainder of 2010. At June 30, 2010, we had a space-sharing agreement covering approximately 10,451 square feet of this facility.
     Operating Leases — Rhode Island
     We continue to have outstanding obligations in regard to our former facilities in Lincoln, Rhode Island. In 1997, we had entered into a fifteen-year lease for a scientific and administrative facility in a sale and leaseback arrangement. The lease includes escalating rent payments. At June 30, 2010, we expect to pay in aggregate, approximately $878,000 in rent and estimated operating expenses before receipt of sub-tenant income, for the remainder of 2010. At June 30, 2010, we expect to receive, in aggregate, approximately $130,000 in sub-tenant rent and operating expenses for the remainder of 2010. As a result of the above transactions, our estimated cash outlay net of sub-tenant rent for the facility will be approximately $748,000 for the remainder of 2010.
     Operating Leases — United Kingdom
     On April 1, 2009, as part of our acquisition of the operations of SCS, we acquired operations in Cambridge, U.K.. As of April 2009, our wholly-owned subsidiary, Stem Cell Sciences (UK) Ltd, had two lease agreements for approximately 3,900 square feet of office and lab space in aggregate in two buildings of the Babraham Research Campus in Cambridge, U.K. One of these two leases, for approximately 2,000 square feet, expired by its terms on February 28, 2010. The second, for approximately 1,900 square feet, had an initial term until March 2011, with an option, at our election, to extend the term for an additional five years. In February 2010, in order to consolidate our operations into a single building at the research campus, we entered into a new lease agreement effective March 1, 2010, for approximately 3,240 square feet. The initial term of this new lease will continue until March 2011, with an option, at our election, to extend the term for an additional two years. The two currently effective Cambridge leases cover in aggregate approximately 5,000 square feet. At June 30, 2010, we expect to pay approximately 69,000 GBP as rental payments for the remainder of 2010 in aggregate for the Cambridge leases. StemCells, Inc. is a guarantor of Stem Cell Sciences (UK) Ltd’s obligations under both leases.

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     With the exception of leases discussed above, we have not entered into any off balance sheet financial arrangements and have not established any special purpose entities. We have not guaranteed any debts or commitments of other entities or entered into any options on non-financial assets.
Contractual Obligations
     In the table below, we set forth our legally binding and enforceable contractual cash obligations at June 30, 2010:
                                                         
    Total                                             Payable in  
    Obligations     Payable in (July to                                     2015  
    at June     December)     Payable in     Payable in     Payable in     Payable in     and  
    30, 2010     2010     2011     2012     2013     2014     Beyond  
Operating lease payments(1)
  $ 6,363,015     $ 1,773,531     $ 2,685,187     $ 1,171,875     $ 732,422     $     $  
Capital lease (equipment)
    128,416       36,696       73,391       18,329                    
Bonds Payable (principal & interest)(2)
    978,784       121,352       242,321       240,666       237,593       136,852        
 
                                         
 
                                                       
Total contractual cash obligations
  $ 7,470,215     $ 1,931,579     $ 3,000,899     $ 1,430,870     $ 970,015     $ 136,852     $  
 
                                         
 
(1)   Operating lease payments exclude space-sharing and sub-lease income (see “Off-Balance Sheet Arrangements — Operating Leases” above for further information), but include rent payments for our Rhode Island facility that are included as part of our “Accrued wind-down expenses” in our condensed consolidated financial statements. See Note 7, “Wind-down expenses” and Note 8, “Commitments and Contingencies” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
 
(2)   See Note 8, “Commitments and Contingencies” in the notes to condensed consolidated financial statements of Part I, Item 1 of this Form 10-Q for further information.
     Under license agreements with NeuroSpheres, Ltd., we obtained an exclusive patent license covering all uses of certain neural stem cell technology. We made up-front payments to NeuroSpheres of 65,000 shares of our common stock and $50,000, and will make additional cash payments as stated milestones are achieved. Effective in 2004, we were obligated to pay annual payments of $50,000, creditable against certain royalties. Effective in 2008, as part of the indemnification agreement with NeuroSpheres described above, we offset the annual $50,000 obligation against litigation costs incurred under that agreement.
     We periodically enter into licensing agreements with third parties to obtain exclusive or non-exclusive licenses for certain technologies. The terms of certain of these agreements require us to pay future milestone payments based upon achievement of certain developmental, regulatory or commercial milestones. We do not anticipate making any milestone payments under any of our licensing agreements for 2010. Milestone payments beyond fiscal year 2010 cannot be predicted or estimated, due to the uncertainty of achieving the required developmental, regulatory or commercial milestones.
     We do not have any material unconditional purchase obligations or commercial commitments related to capital expenditures, clinical development, clinical manufacturing, or other external services contracts at June 30, 2010.
Recent Accounting Pronouncements
     In January 2010, the Financial Accounting Standards Board (FASB), issued new standards to update and amend existing standards on Fair Value Measurements and Disclosures. These standards require new disclosures on the amount and reason for transfers in and out of Level 1 and Level 2 fair value measurements. The standards also require disclosure of activities in Level 3 fair value measurements that use significant unobservable inputs, including purchases, sales, issuances, and settlements. The standards also clarify existing disclosure requirements on levels of disaggregation, which requires fair value measurement disclosure for each class of assets and liabilities, and disclosures about valuation techniques and inputs used to measure fair value of recurring and non recurring fair value measurements that fall in ether Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for our interim and annual reporting periods beginning January 1, 2010, except for the disclosures about purchases, sales,

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issuances and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for our fiscal year beginning January 1, 2011. We do not expect the adoption of the new standards related to Level 3 fair value measurements on January 1, 2011 to have a material effect on our consolidated financial condition and results of operations.
     In April 2010, FASB issued Accounting Standards Update (ASU), Revenue Recognition—Milestone Method, which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Research or development arrangements frequently include payment provisions whereby a portion or all of the consideration is contingent upon milestone events such as successful completion of phases in a study or achieving a specific result from the research or development efforts. The amendments in this ASU provide guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. The ASU is effective for fiscal years and interim periods within those years beginning on or after June 15, 2010, with early adoption permitted. This ASU is effective for our interim and annual reporting periods beginning January 1, 2011. We are currently evaluating the impact of this new standard, if any on our financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     Our market risks at June 30, 2010 have not changed materially from those discussed in Item 7A of our Form 10-K for the year ended December 31, 2009 on file with the U.S. Securities and Exchange Commission.
     See also Note 2, “Financial Assets,” in the notes to condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES
     In response to the requirement of the Sarbanes-Oxley Act of 2002, as of the end of the period covered by this report, our chief executive officer and chief financial officer, along with other members of management, reviewed the effectiveness of the design and operation of our disclosure controls and procedures. Such controls and procedures are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the chief executive officer and the chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are effective.
     During the most recent quarter, there were no changes in internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, these controls of the Company.
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
     In July 2006, we filed suit against Neuralstem, Inc. in the Federal District Court for the District of Maryland, alleging that Neuralstem’s activities violate claims in four of the patents we exclusively licensed from NeuroSpheres. In December 2006, Neuralstem petitioned the U.S. Patent and Trademark Office (PTO) to reexamine two of the patents in our infringement action against Neuralstem, namely U.S. Patent No. 6,294,346 (claiming the use of human neural stem cells for drug screening) and U.S. Patent No. 7,101,709 (claiming the use of human neural stem cells for screening biological agents). In April 2007, Neuralstem petitioned the PTO to reexamine the remaining two patents in the suit, namely U.S. Patent No. 5,851,832 (claiming methods for proliferating human neural stem cells) and U.S. Patent No. 6,497,872 (claiming methods for transplanting human neural stem cells). These requests were

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granted by the PTO and, in June 2007, the parties voluntarily agreed to stay the pending litigation while the PTO considered these reexamination requests. In April 2008, the PTO upheld the ‘832 and ‘872 patents, as amended, and issued Notices of Intent to Issue an Ex Parte Reexamination Certificate for both. In May 2009, the PTO upheld the ‘346 and ‘709 patents, as amended, and issued Notices of Intent to Issue an Ex Parte Reexamination Certificate for both.
     In May 2008, we filed a second patent infringement suit against Neuralstem and its two founders, Karl Johe and Richard Garr. In this suit, which we filed in the Federal District Court for the Northern District of California, we allege that Neuralstem’s activities infringe claims in two patents we exclusively license from NeuroSpheres, specifically U.S. Patent No. 7,361,505 (claiming composition of matter of human neural stem cells derived from any source material) and U.S. Patent No. 7,115,418 (claiming methods for proliferating human neural stem cells). In addition, we allege various state law causes of action against Neuralstem arising out of its repeated derogatory statements to the public about our patent portfolio. Also in May 2008, Neuralstem filed suit against us and NeuroSpheres in the Federal District Court for the District of Maryland seeking a declaratory judgment that the ‘505 and ‘418 patents are either invalid or are not infringed by Neuralstem and that Neuralstem has not violated California state law. In August 2008, the California court transferred our lawsuit against Neuralstem to Maryland for resolution on the merits. In July 2009, the Maryland District Court granted our motion to consolidate these two cases with the litigation we initiated against Neuralstem in 2006. In August 2009, the Maryland District Court approved a scheduling order submitted by the parties for discovery and trial.
     In addition to the actions described above, in April 2008, we filed an opposition to Neuralstem’s European Patent No. 0 915 968 (methods of isolating, propagating and differentiating CNS stem cells), because the claimed invention is believed by us to be unpatentable over prior art, including patents exclusively licensed by us from NeuroSpheres. Neuralstem has responded to this opposition and the parties are currently awaiting a hearing, expected to be held in 2010. In September 2009, we also filed a request with the PTO to reexamine Neuralstem’s U.S. Patent No. 5,753,506 (methods of isolating, propagating and differentiating CNS stem cells), which is the U.S. counterpart of Neuralstem’s ‘968 patent in Europe. In January 2010, we filed a request with the PTO to reexamine Neuralstem’s U.S. Patent No. 7,544,511 (methods for immortalizing neural stem cells using a c-myc construct), which is a continuation in part of the ‘506 patent. In June 2010, we filed a request with the PTO to reexamine Neuralstem’s U.S. Patent No. 6,040,180 (in vitro generation of differentiated neurons from cultures of mammalian multi-potential CNS stem cells), which is also a continuation in part of the ‘506 patent, because the invention is believed by us to be unpatentable over prior art, including patents exclusively licensed by us from NeuroSpheres. All three requests have been granted by the PTO and all three reexaminations are ex parte proceedings to allow the PTO to reconsider the patentability of Neuralstem’s neural stem cell patents.
ITEM 1A. RISK FACTORS
     There have been no material change from the risk factors disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
     None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
     None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
     On June 3, 2010, we held our 2010 Annual Meeting of Stockholders (the “Annual Meeting”). Only stockholders of record as of the close of business on April 9, 2010 were entitled to vote at the Annual Meeting. As of April 9, 2010, there were 119,673,325 shares of our common stock outstanding and entitled to vote at the Annual Meeting, of which 91,848,139 shares of our common stock were represented, in person or by proxy, constituting a quorum.
     The final results of the stockholder vote on each proposal brought before the meeting were as follows:

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  (a)   Each of the two nominees to serve as Class I Directors for a three-year term expiring at the 2013 Annual Meeting were elected.
                         
Nominee   Votes For   Votes Withheld   Broker Non-Votes
 
Eric Bjerkholt
    16,390,960       1,587,821       73,869,358  
John Schwartz, Ph.D.
    15,976,736       2,002,045       73,869,358  
  (b)   The appointment of Grant Thornton LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2010 was ratified.
             
Votes For   Votes Against   Abstentions   Broker Non-Votes
 
88,145,229   2,804,641   898,269   0
ITEM 5. OTHER INFORMATION
     None.
ITEM 6. EXHIBITS
Exhibit 31.1 — Certification of Martin McGlynn under Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 — Certification of Rodney K. B. Young under Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 — Certification of Martin McGlynn Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 — Certification of Rodney K. B. Young Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  STEMCELLS, INC.
(name of Registrant)
 
 
August 9, 2010  /s/ Rodney K. B. Young    
  Rodney K. B. Young   
  Chief Financial Officer   
 

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Exhibit Index
Exhibit 31.1 — Certification of Martin McGlynn under Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 — Certification of Rodney K. B. Young under Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 — Certification of Martin McGlynn Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 — Certification of Rodney K. B. Young Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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