** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTOND.C. 20549**

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**FORM 10-QSB**

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**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**FOR THE PERIOD ENDED JUNE 30,2006**

OR

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**FORTHE TRANSITION PERIOD FROM           TO          .**

**COMMISSIONFILE NUMBER: 0-50295**

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**ADVANCED CELL TECHNOLOGY, INC.**

(EXACT NAME OF SMALLBUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
| **DELAWARE**                    | **87-0656515**                        |
|---------------------------------|---------------------------------------|
| (STATE OR OTHER JURISDICTION OF | (I.R.S. EMPLOYER  IDENTIFICATION NO.) |
| INCORPORATION OR ORGANIZATION)  |                                  |

 

**1201 HARBOR BAY PARKWAY,ALAMEDA, CALIFORNIA 94502**

(ADDRESS, INCLUDING ZIPCODE, OF PRINCIPAL EXECUTIVE OFFICES)

REGISTRANT’S TELEPHONENUMBER, INCLUDING AREA CODE: **(510) 748-4900**

SECURITIES REGISTEREDPURSUANT TO SECTION 12(b) OF THE ACT: **None**

SECURITIES REGISTEREDPURSUANT TO SECTION 12(g) OF THE ACT: **Common Stock, $0.001 par value per share**

Indicate by check markwhether the small business issuer (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the smallbusiness issuer was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes x   No o

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

| **Class:**                               | ** ** | **Outstanding  at_July 25, 2006:** |
|------------------------------------------|------------|------------------------------------|
| Common Stock, $0.001 par value per share |       | 27,690,915 shares             |

 

TransitionalSmall Business Disclosure format (check one)

Yes o   No x

 

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# ** **

# **ADVANCED CELL TECHNOLOGY, INC.**

# **INDEX**

| PART I. FINANCIAL  INFORMATION                                     |   |   |
|-------------------------------------------------------------------------|--------|--------|
| ITEM  1. FINANCIAL STATEMENTS                                           |   |   |
| ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN  OF OPERATION |   |   |
| ITEM 3. CONTROLS AND PROCEDURES                                         |   |   |
| PART II.  OTHER INFORMATION                                        |   |   |
| ITEM  1. LEGAL PROCEEDINGS                                              |   |   |
| ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS    |   |   |
| ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                 |   |   |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS            |   |   |
| ITEM  5. OTHER INFORMATION                                              |   |   |
| ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                           |   |   |
| SIGNATURE                                                               |   |   |

 

**CAUTIONARY NOTEREGARDING FORWARD-LOOKING STATEMENTS**

This Quarterly Report on Form 10-QSB andthe materials incorporated herein by reference contain forward-lookingstatements that involve risks and uncertainties. We use words such as “may,” “assumes,”“forecasts,” “positions,” “predicts,” “strategy,” “will,” “expects,” “estimates,”“anticipates,” “believes,” “projects,” “intends,” “plans,” “budgets,” “potential,”“continue” and variations thereof, and other statements contained in quarterlyreport, and the exhibits hereto, regarding matters that are not historicalfacts and are forward-looking statements. Because these statements involve risksand uncertainties, as well as certain assumptions, actual results may differmaterially from those expressed or implied by such forward-looking statements.Factors that could cause actual results to differ materially include, but arenot limited to risks inherent in:  ourearly stage of development, including a lack of operating history, lack ofprofitable operations and the need for additional capital; the development andcommercialization of largely novel and unproven technologies and products; ourability to protect, maintain and defend our intellectual property rights;uncertainties regarding our ability to obtain the capital resources needed tocontinue research and development operations and to conduct research,preclinical development and clinical trials necessary for regulatory approvals;uncertainty regarding the outcome of clinical trials and our overall ability tocompete effectively in a highly complex, rapidly developing, capital intensiveand competitive industry. See “RISK FACTORS THAT MAY AFFECT OUR BUSINESS”set forth on page 23 herein for a more complete discussion of thesefactors. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date that they are made.We undertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.

Forward-looking statements include our plans andobjectives for future operations, including plans and objectives relating toour products and our future economic performance. Assumptions relating to theforegoing involve judgments with respect to, among other things, futureeconomic, competitive and market conditions, future business decisions, and thetime and money required to successfully complete development andcommercialization of our technologies, all of which are difficult or impossibleto predict accurately and many of which are beyond our control. Although webelieve that the assumptions underlying the forward-looking statementscontained herein are reasonable, any of those assumptions could proveinaccurate and, therefore, we cannot assure you that the results contemplatedin any of the forward-looking statements contained herein will be realized.Based on the significant uncertainties inherent in the forward-lookingstatements included herein, the inclusion of any such statement should not beregarded as a representation by us or any other person that our objectives orplans will be achieved.

2

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** **

**PART I. FINANCIAL INFORMATION**

**ITEM 1. FINANCIALSTATEMENTS**

**ADVANCEDCELL TECHNOLOGY, INC. AND SUBSIDIARY****BALANCE SHEET**
| ** **                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                          | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                                                                          | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                              |       |              |       |                  |       |
|                                                                                                                                |       |              |       |                  |       |
| Current assets:                                                                                                                     |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                           |       | $                 | 5,306,897  |                  | $          | 13,857,901 |   |
| Accounts receivable, net of allowance for doubtful  accounts of $636,399 (unaudited) and $636,399                                   |       | 48,249            |       | 134,876               |       |
| Prepaid expenses                                                                                                                    |       | 114,988           |       | 173,040               |       |
| Deferred royalty fees, current portion                                                                                              |       | 247,975           |       | 119,763               |       |
|                                                                                                                                |       |              |       |                  |       |
| Total current  assets                                                                                                               |       | 5,718,109         |       | 14,285,580            |       |
|                                                                                                                                |       |              |       |                  |       |
| Property and  equipment, net                                                                                                        |       | 1,183,540         |       | 807,411               |       |
|                                                                                                                                |       |              |       |                  |       |
| Deferred royalty  fees, less current portion                                                                                        |       | 1,085,356         |       | 598,811               |       |
| Deposits                                                                                                                            |       | 132,341           |       | 105,192               |       |
| Deferred  issuance costs, net of amortization of $414,059 (unaudited) and $207,029                                                  |       | 1,863,263         |       | 2,277,322             |       |
|                                                                                                                                |       |              |       |                  |       |
| Total assets                                                                                                                        |       | $                 | 9,982,609  |                  | $          | 18,074,316 |   |
|                                                                                                                                |       |              |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ DEFICIT                                                                                         |       |              |       |                  |       |
|                                                                                                                                |       |              |       |                  |       |
| Current liabilities:                                                                                                                |       |              |       |                  |       |
| Accounts payable                                                                                                                    |       | $                 | 1,501,729  |                  | $          | 2,113,983 |   |
| Accrued expenses                                                                                                                    |       | 1,219,818         |       | 1,251,946             |       |
| Deferred revenue, current portion                                                                                                   |       | 370,009           |       | 332,508               |       |
| Interest payable                                                                                                                    |       | 109,583           |       | 87,083                |       |
| Advances payable - other                                                                                                            |       | 130,000           |       | 130,000               |       |
| Convertible debenture and embedded derivatives, net  of discounts of $4,641,719 (unaudited) and $5,312,858                          |       | 5,844,119         |       | 5,144,896             |       |
| Warrant derivatives - current portion                                                                                               |       | 573,566           |       | —                |       |
| Capital leases                                                                                                                      |       | 77,594            |       | —                |       |
| Notes payable - other and capital leases, net of  discounts of $263,463 (unaudited) and $314,456                               |       | 1,106,356         |       | 858,103               |       |
|                                                                                                                                |       |              |       |                  |       |
| Total current liabilities                                                                                                           |       | 10,932,774        |       | 9,918,519             |       |
|                                                                                                                                |       |              |       |                  |       |
| Convertible debenture and embedded derivatives, less  current portion and net of discounts of $4,867,063 (unaudited) and $9,297,501 |       | 6,126,778         |       | 9,003,569             |       |
| Warrant derivatives, less current portion                                                                                           |       | 7,397,733         |       | 30,994,491            |       |
| Capital leases                                                                                                                      |       | 70,951            |       | 109,924               |       |
| Deferred revenue, net of current portion                                                                                            |       | 1,496,288         |       | 1,662,542             |       |
|                                                                                                                                |       |              |       |                  |       |
| Total  liabilities                                                                                                                  |       | 26,024,524        |       | 51,689,045            |       |
|                                                                                                                                |       |              |       |                  |       |
| Stockholders’ deficit:                                                                                                         |       |              |       |                  |       |
| Common stock, $0.001 par value; 100,000,000 shares  authorized, 25,823,714 and 23,440,695 issued and outstanding                    |       | 25,823            |       | 23,441                |       |
| Additional paid-in capital                                                                                                          |       | (7,000,555        | )          | (10,463,008           | )          |
| Deferred compensation                                                                                                               |       | (21,585           | )          | (21,585               | )          |
| Accumulated deficit                                                                                                                 |       | (9,045,598        | )          | (23,153,577           | )          |
|                                                                                                                                |       |              |       |                  |       |
| Total  stockholders’ deficit                                                                                                   |       | (16,041,915       | )          | (33,614,729           | )          |
|                                                                                                                                |       |              |       |                  |       |
| Total liabilities and  stockholders’ deficit                                                                                   |       | $                 | 9,982,609  |                  | $          | 18,074,316 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

3

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**ADVANCED CELL TECHNOLOGY, INC. ANDSUBSIDIARYSTATEMENTS OF OPERATIONS(UNAUDITED)**
| ** **                                                          | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** **  |
|---------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|-------------|
| ** **                                                          | ** ** | **2006**                                            | ** ** | **2005**                                          | ** **  | **2006** | ** ** | **2005** | ** ** |
| Revenue:                                                            |       |                                                |       |                                              |        |   |   |   |   |
| License fees and  royalties                                         |       | $                                                   | 120,627    |                                              | $           | 120,626 |   | $ | 203,754 |   | $ | 228,753 |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Cost of revenue                                                     |       | 92,618                                              |       | 58,251                                            |        | 153,807 |   | 103,942 |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Gross profit                                                        |       | 28,009                                              |       | 62,375                                            |        | 49,947 |   | 124,811 |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Operating expenses:                                                 |       |                                                |       |                                              |        |   |   |   |   |
| Research and  development                                           |       | 2,617,207                                           |       | 657,024                                           |        | 4,425,773 |   | 933,619 |   |
| Grant  reimbursements                                               |       | (162,662                                            | )          | (189,408                                          | )           | (363,567 | ) | (425,218 | ) |
| General and  administrative                                         |       | 1,878,085                                           |       | 2,037,020                                         |        | 4,508,122 |   | 3,241,500 |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Total operating  expenses                                           |       | 4,332,630                                           |       | 2,504,636                                         |        | 8,570,328 |   | 3,749,901 |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Loss from operations                                                |       | (4,304,621                                          | )          | (2,442,261                                        | )           | (8,520,381 | ) | (3,625,090 | ) |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Other income (expense):                                             |       |                                                |       |                                              |        |   |   |   |   |
| Interest income                                                     |       | 81,382                                              |       | 13,852                                            |        | 199,848 |   | 25,959 |   |
| Gain on sale of  asset                                              |       | 767,040                                             |       | —                                            |        | 767,040 |   | — |   |
| Gain on  settlement of debt                                         |       | —                                              |       | —                                            |        | — |   | 86,513 |   |
| Interest expense  and late fees                                     |       | (2,516,292                                          | )          | (18,605                                           | )           | (5,597,306 | ) | (68,729 | ) |
| Interest expense  - stockholder                                     |       |                                                |       | (30,000                                           | )           | — |   | (60,000 | ) |
| Adjustments to  fair value of derivatives                           |       | 15,267,101                                          |       | —                                            |        | 27,258,778 |   | — |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Total other income  (expense)                                       |       | 13,599,231                                          |       | (34,753                                           | )           | 22,628,360 |   | (16,257 | ) |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Net Profit / (loss)                                                 |       | $                                                   | 9,294,610  |                                              | $(2,477,014 | ) | $ | 14,107,979 |   | $(3,641,347 | ) |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Basic earnings per  share                                           |       | $                                                   | 0.38       |                                              | $           | (0.11 | ) | $ | 0.57 |   | $ | (0.16 | ) |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Diluted earnings per  share                                         |       | $                                                   | 0.17       |                                              | $           | — |   | $ | 0.27 |   | $ | — |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Weighted average shares  used in computation of earnings per share: |       |                                                |       |                                              |        |   |   |   |   |
| Basic                                                               |       | 24,478,469                                          |       | 23,225,212                                        |        | 24,830,321 |   | 23,219,212 |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |
| Diluted                                                             |       | 56,487,483                                          |       |                                              |        | 56,839,335 |   |   |   |
|                                                                |       |                                                |       |                                              |        |   |   |   |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

4

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**ADVANCED CELL TECHNOLOGY, INC. ANDSUBSIDIARYSTATEMENTS OF CASH FLOWSCHANGE IN CASH AND CASH EQUIVALENTS(UNAUDITED)**
| ** **                                                                                             | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                 |       |                                              |       |   |   |
| Net profit /  (loss)                                                                                   |       | $                                                 | 14,107,979 |   | $(3,641,347 | ) |
| Adjustments to  reconcile net profit / (loss) to net cash (used in) provided by operating  activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                                          |       | 101,998                                           |       | 45,504 |   |
| Bad debt                                                                                               |       | —                                            |       | 32,715 |   |
| Amortization of deferred charges                                                                       |       | 108,807                                           |       | 59,880 |   |
| Amortization of deferred revenue                                                                       |       | (166,253                                          | )          | — |   |
| Stock based compensation                                                                               |       | 192,485                                           |       | 106,988 |   |
| Amortization of deferred offering costs                                                                |       | 414,059                                           |       | — |   |
| Gain on settlement of accounts payable                                                                 |       | —                                            |       | (86,513 | ) |
| Shares issued for services                                                                             |       | —                                            |       | 15,000 |   |
| Warrants issued for services                                                                           |       | 331,827                                           |       | — |   |
| Amortization of deferred compensation                                                                  |       | 48,290                                            |       | 6,768 |   |
| Amortization of discounts                                                                              |       | 5,330,649                                         |       | — |   |
| Changes in fair value of equity instruments                                                            |       | (27,258,778                                       | )          | — |   |
|                                                                                                   |       |                                              |       |   |   |
| Changes in  operating assets and liabilities:                                                          |       |                                              |       |   |   |
| (Increase)  decrease in:                                                                               |       |                                              |       |   |   |
| Accounts receivable                                                                                    |       | 86,627                                            |       | 42,435 |   |
| Prepaid expenses                                                                                       |       | 58,052                                            |       | (113,252 | ) |
| Due from stockholder                                                                                   |       | —                                            |       | (261,615 | ) |
| Deferred charges                                                                                       |       | (485,000                                          | )          | (22,500 | ) |
| Deposits                                                                                               |       | (27,149                                           | )          | (65,000 | ) |
| Increase (decrease) in:                                                                                |       |                                              |       |   |   |
| Accounts payable and accrued expenses                                                                  |       | (175,957                                          | )          | 331,939 |   |
| Interest payable                                                                                       |       | 22,500                                            |       | 100,769 |   |
| Deferred revenue                                                                                       |       | 37,500                                            |       | (166,253 | ) |
|                                                                                                   |       |                                              |       |   |   |
| Net cash used in  operating activities                                                                 |       | (7,272,364                                        | )          | (3,614,482 | ) |
|                                                                                                   |       |                                              |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                 |       |                                              |       |   |   |
| Cash acquired in  acquisition                                                                          |       | —                                            |       | 10,000 |   |
| Purchases of  property and equipment                                                                   |       | (478,126                                          | )          | (213,513 | ) |
|                                                                                                   |       |                                              |       |   |   |
| Net cash used in  investing activities                                                                 |       | (478,126                                          | )          | (203,513 | ) |
|                                                                                                   |       |                                              |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                 |       |                                              |       |   |   |
| Proceeds from  preferred unit subscriptions, net of cost                                               |       | —                                            |       | 3,639,530 |   |
| Proceeds from  exercise of warrants                                                                    |       | 6,100                                             |       | — |   |
| Payments of  convertible Debentures                                                                    |       | (767,639                                          | )          | — |   |
| Payments on  notes and leases                                                                          |       | (38,975                                           | )          | (250,000 | ) |
| Cash overdraft                                                                                         |       | —                                            |       | (1,409 | ) |
|                                                                                                   |       |                                              |       |   |   |
| Net cash  provided by (used in) financing activities                                                   |       | (800,514                                          | )          | 3,388,121 |   |
|                                                                                                   |       |                                              |       |   |   |
| Net decrease in  cash                                                                                  |       | (8,551,004                                        | )          | (429,874 | ) |
|                                                                                                   |       |                                              |       |   |   |
| Cash and cash  equivalents, beginning of period                                                        |       | $                                                 | 13,857,901 |   | $ | 3,676,000 |   |
|                                                                                                   |       |                                              |       |   |   |
| Cash and cash  equivalents, end of period                                                              |       | $                                                 | 5,306,897  |   | $ | 3,246,126 |   |
|                                                                                                   |       |                                              |       |   |   |
| Cash paid for:                                                                                         |       |                                              |       |   |   |
| Interest                                                                                               |       | $                                                 | 5,013      |   | $ | — |   |
| Income taxes                                                                                           |       | $                                                 | —     |   | $ | — |   |

 

Supplementalschedule of non-cash financing activities:

During the six monthsended June 30, 2006:

The Company issuedapproximately 1,840,000 shares of common stock in redemption of convertibledebentures with a face value of approximately $2,181,000.

The Company issuedapproximately 290,000 shares of common stock in conversion of convertibledebentures with a face value of approximately $846,000.

The Company issuedapproximately 163,000 shares of common stock in payment of license fees valuedat approximately $239,000.

The accompanying notesare an integral part of these consolidated financial statements.

5

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**ADVANCED CELL TECHNOLOGY, INC. AND SUBSIDIARYSTATEMENT OF STOCKHOLDERS’ DEFICITFOR THE SIX MONTH PERIOD ENDED JUNE 30, 2006 (UNAUDITED)**

 
| ** **                                        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | ** **             | ** ** | **Total**   | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|------------------------|------------|-------------|------------|
| ** **                                        | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Deferred**   | ** ** | **Accumulated**  | ** ** | **Stockholders’** | ** ** |
| ** **                                        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Deficit**            | ** ** | **Deficit** | ** ** |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Balance at December 31, 2005                      |       | 23,440,695            |       | $           | 23,441     |           | $          | (10,463,008      | )          | $                      | (21,585    | )           | $          | (23,153,577 | ) | $ | (33,614,728 | ) |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Cashless Exercise of warrant                      |       | 63,208                |       | 63          |       | (63            | )          |             |       |                   |       | —      |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Stock option Exercises                            |       | 26,000                |       | 26          |       | 6,074          |       |             |       |                   |       | 6,100       |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Convertible Debenture Redemption                  |       | 1,839,977             |       | 1,840       |       | 2,179,770      |       |             |       |                   |       | 2,181,610   |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Convertible Debenture Conversion                  |       | 290,435               |       | 290         |       | 845,787        |       |             |       |                   |       | 846,077     |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Option compensation charges                       |       |                  |       |        |       | 192,485        |       |             |       |                   |       | 192,485     |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Issuance of stock in payment of license fees      |       | 163,399               |       | 163         |       | 238,400        |       |             |       |                   |       | 238,563     |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Net profit for the six months ended June 30, 2006 |       |                  |       |        |       |           |       |             |       | 14,107,979             |       | 14,107,979  |       |
|                                              |       |                  |       |        |       |           |       |             |       |                   |       |        |       |
| Balance at June  30, 2006                         |       | 25,823,714            |       | $           | 25,823     |           | $          | (7,000,555       | )          | $                      | (21,585    | )           | $          | (9,045,598 | ) | $ | (16,041,915 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

6

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**ADVANCED CELLTECHNOLOGY, INC. AND SUBSIDIARYNOTES TO FINANCIAL STATEMENTSJUNE 30, 2006(UNAUDITED)**

**1.**                 ORGANIZATIONALMATTERS

**Organization**

On January 31, 2005, Advanced CellTechnology, Inc. (formerly known as A.C.T. Holdings, Inc.) (the “Company”)completed the Merger with Advanced Cell, Inc. (formerly known as AdvancedCell Technology, Inc.), a Delaware corporation (“ACT”), pursuant to whicha wholly-owned subsidiary of the Company merged with and into ACT, with ACTremaining as the surviving corporation and a wholly-owned subsidiary of theCompany. Upon the completion of the merger, the Company ceased all of itspre-merger operations and adopted the business of ACT.

Prior to the merger, the Company had minimal business,operations, revenues and assets, and had been involved in an industry entirelyunrelated to the business of ACT. Therefore, the acquisition of ACT by theCompany represented a complete change in the nature of the Company’s businessand operations, and changed the nature of any prior investment in the Company.

The transaction has been accounted for as arecapitalization of ACT, the accounting acquirer. The historical financialstatements presented for periods prior to the merger are those of ACT.

On November 18, 2005, a majority of the Company’sstockholders approved the reincorporation of the Company from the state ofNevada to the state of Delaware pursuant to a merger of the Company with andinto a newly formed Delaware corporation, followed by a “roll up” merger tocombine the operating subsidiary with the Company.

**Nature of Business**

The Company is a biotechnology company focused ondeveloping and commercializing human stem cell technology in the emergingfields of regenerative medicine and stem cell therapy. Principal activities todate have included obtaining financing, securing operating facilities andconducting research and development. The Company has no therapeutic productscurrently available for sale and does not expect to have any therapeuticproducts commercially available for sale for a period of years, if at all.These factors indicate that the Company’s ability to continue its research anddevelopment activities is dependent upon the ability of management to obtainadditional financing as required.

**Going Concern**

As reflected in the accompanying financial statements,the Company has losses from operations, negative cash flows from operations anda substantial stockholders’ deficit. These matters raise substantial doubtabout the Company’s ability to continue as a going concern and fund cashrequirements for operations through June 30, 2007. Subsequent to filing theForm 10-KSB for the year ended December 31, 2005, the Company obtained newinformation which negatively impacted cash flows forecasted through March 31,2007. The Company’s Board of Directors met and approved an operating plan atcurrent spending levels, assuming additional capital is raised during the currentyear. In addition, as more fully disclosed in Note 11—Subsequent Events, theCompany has experienced increases in cash redemptions of convertibledebentures.

In view of the matters described in the precedingparagraph, recoverability of a major portion of the recorded asset amountsshown in the accompanying balance sheet is dependent upon continued operationsof the Company, which, in turn, is dependent upon the Company’s ability tocontinue to raise capital and ultimately generate positive cash flows fromoperations. The financial statements do not include any adjustments relating tothe recoverability and classification of recorded asset amounts or amounts andclassifications of liabilities that might be necessary should the Company beunable to continue its existence.

7

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In the first six months of 2006, management has taken orplans to take the following steps that it believes will be sufficient toprovide the Company with the ability to continue in existence:

·                     As describedmore fully in Note 3 — Convertible Debentures, the financing completed inSeptember 2005 contains provisions regarding a potential “second closing” offinancing of $8,875,000 net of discounts. The Company is engaged in ongoingdiscussions with its convertible debenture holders regarding the exercise of theseprovisions of the debenture agreement. No commitments have been received fromdebenture holders and no assurance that this financing will ultimately becompleted.

·                     Managementanticipates raising additional capital from its current convertible debentureholders, or other financing sources, that will be used to fund any capitalshortfalls. The terms of any financing will likey be negotiated based uponcurrent market terms for similar financings. No commitments have been receivedfor additional investment and no assurances can be given that this financingwill ultimately be completed.

·                     Managementhas focused its scientific operations on product development in order toaccelerate the time to market of products which will ultimately generaterevenues. While the amount or timing of such revenues can not be determined,Management believes that focused development will ultimately provide a quickerpath to revenues, and an increased likelihood of raising additional financing.

***Basis ofPresentation —***The accompanying unaudited financialstatements as of June 30, 2006 and for the three and six month periodsended June 30, 2006 and 2005 have been prepared pursuant to therules and regulations of the Securities and Exchange Commission (“SEC”),including Form 10-QSB and Regulation S-B. The information furnishedherein reflects all adjustments (consisting of normal recurring accruals andadjustments), which are, in the opinion of management, necessary to fairlypresent the operating results for the respective periods. Certain informationand footnote disclosures normally present in annual financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been omitted pursuant to such rules andregulations. The Company believes that the disclosures provided are adequate tomake the information presented not misleading. These financial statementsshould be read in conjunction with the audited financial statements andexplanatory notes for the year ended December 31, 2005 as disclosed in theCompany’s annual report on Form 10-KSB for that year as filed withthe SEC and in conjunction with ACT’s audited financial statements. Interimresults of operations are not necessarily indicative of the results to beexpected for the year ending December 31, 2006.

**2.**                 SIGNIFICANT ACCOUNTING POLICIES

***Stock-BasedCompensation —***At June 30, 2006, the Company has twostock-based employee compensation plans, which are described more fully in Note6. Prior to January 1, 2006, the Company accounted for those plans underthe recognition and measurement provisions of APB Opinion No. 25,Accounting for Stock Issued to Employees, and related Interpretations, aspermitted by FASB Statement No. 123, Accounting for Stock-BasedCompensation. No stock-based employee compensation cost was recognized in theStatement of Operations for the years ended December 31, 2005 or 2004, asall options granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant.

As more fully discussed in Note 6, effectiveJanuary 1, 2006, the Company adopted the fair value recognition provisionsof FASB Statement No. 123(R), Share-Based Payment, using themodified-prospective-transition method. Under that transition method,compensation cost recognized in the three and six months ended June 30,2006 includes: (a) compensation cost for all share-based payments grantedprior to, but not yet vested as of January 1, 2006, based on the grantdate fair value estimated in accordance with the original provisions of Statement123, and (b) compensation cost for all share-based payments grantedsubsequent to January 1, 2006, based on the grant-date fair valueestimated in accordance with the provisions of Statement 123(R). Results forprior periods have not been restated.

8

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***Earnings per Share***

The Company uses SFAS No. 128, “Earnings PerShare” for calculating the basic and diluted loss per share. Basic loss pershare is computed by dividing net income by the weighted average number ofcommon shares outstanding. Diluted income per share is computed similar tobasic loss per share except that the denominator is increased to include theaverage number of additional common shares that would have been outstanding ifthe potential common shares had been issued and if the additional common shareswere dilutive. Using the treasury stock method, the effect of stock awards onthe weighted average shares used in the computation of diluted earnings pershare was approximately 19,000,000 shares for the six months ended June 30,2006. Additional dilutive shares are primarily related to convertibledebentures more fully described in Note 3—Convertible Debentures.

For the three and six months ended June 30, 2005approximately 23 million potential shares were excluded from the sharesused to calculate diluted earnings per share as their inclusion would reducenet loss per share.

The followingtables provide a reconciliation of the numerators and denominators of the basicand diluted EPS for the three and six months ended June 30, 2006:
| ** **                                                     | ** ** | **For the Three Months Ended June 30, 2006** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Income  (Numerator)**                                                         | ** ** | **Shares  (Denominator)** | ** ** | **Per-Share  Amount** | ** ** |
| Income                                                         |       | $                                                                               | 9,294,610  |   |  |   |  |   |
|                                                           |       |                                                                            |       |   |   |   |   |
| **Basic  EPS**                                                 |       |                                                                                 |       |  |   |  |   |
| ** **                                                     | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income available  to common stockholders                       |       | 9,294,610                                                                       |       | 24,478,469 |   | $ | 0.38 |   |
|                                                           |       |                                                                            |       |   |   |   |   |
| **Effect  of Dilutive Securities**                             |       |                                                                                 |       |  |   |  |   |
| ** **                                                     | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Warrants                                                       |       |                                                                                 |       | 11,702,082 |   |  |   |
|                                                           |       |                                                                            |       |   |   |   |   |
| Convertible  Debentures                                        |       | 577,593                                                                         |       | 19,883,237 |   |  |   |
|                                                           |       |                                                                            |       |   |   |   |   |
| Stock Options                                                  |       |                                                                            |            | 423,695 |   |   |   |
|                                                           |       |                                                                            |       |   |   |   |   |
| **Diluted  EPS**                                               |       |                                                                                 |       |  |   |  |   |
| ** **                                                     | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income available to  common stockholders + assumed conversions |       | $                                                                               | 9,872,203  |   | 56,487,483 |   | $ | 0.17 |   |

 

9

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| ** **                                                     | ** ** | **For the Six Months Ended June 30, 2006** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **Income  (Numerator)**                                                       | ** ** | **Shares  (Denominator)** | ** ** | **Per-Share  Amount** | ** ** |
| Income                                                         |       | $                                                                             | 14,107,979 |   |  |   |  |   |
|                                                           |       |                                                                          |       |   |   |   |   |
| **Basic  EPS**                                                 |       |                                                                               |       |  |   |  |   |
| ** **                                                     | ** ** | ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income available  to common stockholders                       |       | 14,107,979                                                                    |       | 24,830,321 |   | $ | 0.57 |   |
|                                                           |       |                                                                          |       |   |   |   |   |
| **Effect  of Dilutive Securities**                             |       |                                                                               |       |  |   |  |   |
| ** **                                                     | ** ** | ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Warrants                                                       |       |                                                                               |       | 11,702,082 |   |  |   |
|                                                           |       |                                                                          |       |   |   |   |   |
| Convertible  Debentures                                        |       | 1,188,095                                                                     |       | 19,883,237 |   |  |   |
|                                                           |       |                                                                          |       |   |   |   |   |
| Stock Options                                                  |       |                                                                          |            | 423,695 |   |   |   |
|                                                           |       |                                                                          |       |   |   |   |   |
| **Diluted  EPS**                                               |       |                                                                               |       |  |   |  |   |
| ** **                                                     | ** ** | ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income available to  common stockholders + assumed conversions |       | $                                                                             | 15,296,074 |   | 56,839,335 |   | $ | 0.27 |   |

 

Options to purchaseapproximately 5,900,000 shares of common stock were outstanding during theperiod but were not included in the computation of diluted EPS because theoptions’ exercise price was greater than the average market price of the commonshares. The options were still outstanding at June 30, 2006.

Warrants to purchaseapproximately 3,300,000 shares of common stock were outstanding during theperiod but were not included in the computation of diluted EPS because thewarrants’ exercise price was greater than the average market price of thecommon shares. The warrants were still outstanding at June 30, 2006.

**3.**                 CONVERTIBLEDEBENTURES

On September 15, 2005, we entered into aSecurities Purchase Agreement with accredited investors for the issuance of anaggregate of $22,276,250 principal amount of convertible debentures with anoriginal issue discount of $4,526,250 representing approximately 20.3%. Inconnection with the closing of the sale of the debentures, we received grossproceeds of $17,750,000.

The agreementincluded a number of embedded derivative instruments that required separatevaluation in accordance with the requirements of FAS 133, EITF 05-04and related accounting literature. The following summarizes the fair values ofembedded derivatives at December 31, 2005 and June 30, 2006, followed by adescription of the valuation methodology utilized to determine fair values:

|                                                          | ** ** | **Fair value**             | ** ** | **Fair value**         | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| **Embedded Derivative Liability (Asset)** | ** ** | **December 31, 2005** | ** ** | **June 30, 2006** | ** ** |
| Conversion  feature                                      |       | $                               | 6,057,088  |                        | $          | 119,966 |   |
| Anti-dilution  protection                                |       | 1,755,878                       |       | 2,946,366                   |       |
| Default  provisions                                      |       | 94,886                          |       | 70,242                      |       |
| Right to provide  future financing                       |       | 185,968                         |       | 95,290                      |       |
| Company right to  force conversion                       |       | (1,226,746                      | )          | (4,712                      | )          |
|                                                     |       | $                               | 6,867,074  |                        | $          | 3,227,152 |   |

 

The fair value of the derivative for the conversionfeature was valued as an American call option using the Binomial Option PricingModel with the following inputs: (1) closing stock price of $0.65 at June30, 2006 (2) exercise price equal to the $2.30 conversion price(3) volatility based upon the Company’s stock trading of  78% (4) Treasury note rates with termscommensurate with the remaining term of the Notes ranging from 5.1% to 5.21%,and (5) duration of the note as an amortizing debenture of approximately0.85 years, based upon present values.

10

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The fair value of the derivative for anti-dilutionprotection was valued using a standard put option binomial model, adjusted forthe probability of subsequent financing at prices below the principal’sconversion option with the following inputs: (1) closing stock price as ofthe valuation date of $0.65 (2) exercise price equal to the $2.30conversion price (3) volatility based upon the Company’s stock trading of78% (4) Treasury note rates with terms commensurate with the remainingterm of the Notes of 5.21% and (5) duration of the note as an amortizingdebenture of approximately 0.85 years based upon present values.

The fair value of the derivative for contractualdefault provisions was determined by taking the monthly amortization schedule,and multiplying the result by the contractual penalty of 120%. The presentvalue of this penalty was then adjusted by the estimated probability of defaultfor each valuation date.

The fair value of the derivative for the investors’option to provide future financing was determined using a Black-Scholes OptionPricing Model with the following inputs: (1) The stock and exercise pricewas based on the maximum amount of additional investment of $8,875,000(2) Volatility of 2% was based on the historical volatility of governmentand high yield bond indices (3) Risk free rate of 5.21% was based onTreasury notes and (4) time to maturity was based upon the six monthoption period.

The fair value of the derivative asset related to theCompany’s right to force conversion was based upon a binomial option pricingmodel with the following inputs: (1) closing stock price at the valuationdate of $0.65 (2) exercise price of $4.60 per share which is required forthe forced conversion (3) volatility based upon the Company’s stocktrading of 78% (4) Treasury note rate with terms commensurate with theremaining term of the Notes of 5.16% and (5) duration of the note as anamortizing debenture of approximately 1.47 years based upon presentvalues.

During the three months ended June 30, 2006, adecrease in the fair value of the embedded derivative amounts of approximately$1,000,000 was recorded through results of operations as Adjustment to FairValue of Derivatives.

During the three months ended June 30, 2006, theCompany recorded approximately $2,300,000 as Interest Expense for amortizationof discounts for original issue discount, discount for warrant derivative, andother embedded derivatives identified above.

In connection with this financing, we paid cash feesto a broker-dealer of $1,065,000 and issued a warrant to purchase 1,162,239shares of Common Stock at an exercise price of $2.53 per share. The initialfair value of the warrant was estimated at approximately $1,379,000 using theBlack Scholes pricing model. The assumptions used in the Black Scholes modelare as follows: (1) dividend yield of 0%; (2) expected volatility of64%, (3) risk-free interest rate of 3.99%, and (4) expected life of5 years. Cash fees paid, and the initial fair value of the warrant, havebeen capitalized as debt issuance costs and are being amortized over36 months under the effective interest rate method. Interest expense forthe three months ended June 30, 2006 was approximately $207,000.

The following table summarizes Convertible Debenturesand embedded derivatives outstanding at June 30, 2006:

| Convertible debentures at  face                             |   | $          | 18,253,583 |   |
|-------------------------------------------------------------|--------|------------|------------|--------|
| Discounts on  debentures:                                   |   |       |       |
| Original issue discount                                     |   | (2,397,142 | )          |
| Conversion feature derivative                               |   | (3,901,589 | )          |
| Warrant derivative                                          |   | (3,062,185 | )          |
| Other derivatives                                           |   | (148,923   | )          |
| Net convertible  debentures                                 |   | 8,743,744  |       |
| Embedded  derivatives                                       |   | 3,227,153  |       |
| Convertible  debentures and embedded derivatives            |   | 11,970,897 |       |
| Less current portion                                        |   | (5,844,119 | )          |
| Convertible  debentures and embedded derivatives- long term |   | $          | 6,126,778  |   |

 

11

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** **

**4.**                 WARRANTDERIVATIVES

As described more fully in Note 3 — ConvertibleDebentures, the provisions of our convertible debenture financing completed inSeptember 2005 permit the Company to make its monthly redemption in sharesrather than cash upon satisfaction of certain conditions. Under the terms ofthe debenture agreement, the price per share is variable dependent upon theactual closing price of the Company’s common stock. Accordingly, the totalnumber of shares to retire outstanding principal is variable and the Companycan not be assured that there are adequate authorized shares to settle allcontractual obligations under the debenture agreement, and other option andwarrant agreements outstanding.

Accordingly, in accordance with the provisions of EITF00-19, “Accounting for Derivative Financial Instruments Indexed to andPotentially Settled in a Company’s Own Stock” the Company has reviewed allinstruments previously recorded as permanent equity under EITF 00-19which are described in detail in Note 5—Stockholders’ Equity Transactions.As of September 15, 2005, the closing date of the convertible debenturefinancing, a $25,600,000 increase in the fair value of instruments previouslyrecorded as permanent equity with a value of zero was recorded based upon fairvalues computed under a Black Scholes model with the following assumptions:(1) dividend yield of 0% (2) expected volatility of 64%(3) risk-free interest rate of approximately 3.9% and (4) expectedlife and exercise prices consistent with each individual instrument.

The accumulated fair value of these and otherinstruments at September 15, 2005 of approximately $27,700,000, after theincrease to fair value described above, was reclassified from equity to WarrantDerivative liability in accordance with the requirements of EITF 00-19.

At June 30, 2006 the fair value of each instrument wasagain computed under a Black Scholes model with the following assumptions:(1) dividend yield of 0% (2) expected volatility of 78%(3) risk-free interest rate of approximately 5.2% and (4) expectedlife and exercise prices consistent with each individual instrument. Thesecalculations resulted in an aggregate value of derivative instruments ofapproximately $6,900,000. As a result, for the three months ended June 30, 2006the Company recorded approximately $11,500,000 as a credit to Adjustment toFair Value of Derivatives.

**Of the total proceeds from theissuance of the debentures as more fully described in Note 3, approximately$5,700,000 was initially allocated to the freestanding warrants associated withthe debentures based upon the fair value of the Warrants. The assumptions usedin the Black Scholes model for determining the initial fair value of thewarrants were as follows: (1) dividend yield of 0%; (2) expectedvolatility of 64%, (3) risk-free interest rate of 3.99%, and (4) expected lifeof 5 years. In accordance with FAS 133 “Accounting for Derivative Instrumentsand Hedging Activities”, EITF 00-19 “Accounting for Derivative FinancialInstruments Indexed to and Potentially Settled in a Company’s Own Stock” andEITF 05-04 “The Effect of a Liquidated Damages Clause on a FreestandingFinancial Instrument Subject to EITF Issue No. 00-19”, the amounts allocated tothe warrant represent a derivative liability that has been recorded in theaccompanying balance sheet.**

** The carrying value of warrant derivative atJune 30, 2006 has been adjusted to reflect its “fair value” of approximately$1,049,000 based upon a Black Scholes calculation as follows: (1) dividendyield of 0%; (2) expected volatility of 78%, (3) risk-free interest rate of5.10%, and (4) expected remaining life of 4.25 years. During the period endedJune 30, 2006, a decrease in the fair value of the warrant liability ofapproximately $2,546,000 was recorded through results of operations as a creditto Adjustment to Fair Value of Derivatives.**

**5.**                 STOCKHOLDERS’EQUITY TRANSACTIONS

We are authorized to issue two classes of capitalstock, to be designated, respectively, Preferred Stock and Common Stock. Thetotal number of shares of Preferred Stock we are authorized to issue is50,000,000, par value $0.001 per share. The total number of shares of CommonStock we are authorized to issue is 100,000,000, par value $0.001 per share. Wehad no Preferred Stock outstanding as of June 30, 2006. We had 25,823,714shares of Common Stock outstanding as of June 30, 2006.

In April 2006 the Company issued 320,000 warrantsto purchase common stock at $2.54 per share in connection with consultingservices provided during the quarter. The warrants have been valued at approximately$82,000 using 

12

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the Black Scholes pricing model with the followingassumptions: (1) dividend yield of 0%; (2) expected volatility of78%, (3) risk-free interest rate of 5.10%, and (4) expected life of5.0 years. This warrant is classified as a warrant derivative.

In March 2006 the Company issued 250,000 warrantsto purchase common stock at $2.54 per share in connection with consultingservices provided during the quarter. The warrants have been valued at$156,894, using the Black Scholes pricing model with the following assumptions:(1) dividend yield of 0%; (2) expected volatility of 74%,(3) risk-free interest rate of 4.82%, and (4) expected life of 3.5years. This warrant is classified as a warrant derivative.

**6.**                 OPTIONSOUTSTANDING

**Stock Plans**

On August 12, 2004, ACT’s Board of Directorsapproved the establishment of the 2004 Stock Option Plan (the “*2004 Stock Plan”*). Stockholder approvalwas received on December 13, 2004. The total number of common sharesavailable for grant and issuance under the plan may not exceed 2,800,000shares, subject to adjustment in the event of certain recapitalizations,reorganizations and similar transactions. Common stock purchase options may beexercisable by the payment of cash or by other means as authorized by the Boardof Directors or a committee established by the Board of Directors. At June 30,2006, ACT had granted 2,604,000 common share purchase options under the plan.

On December 13, 2004, ACT’s Board of Directorsand stockholders approved the establishment of the 2004 Stock Option Plan II(the “*2004 Stock Plan II*”). The total number of common sharesavailable for grant and issuance under the plan may not exceed 1,301,161shares, subject to adjustment in the event of certain recapitalizations,reorganizations and similar transactions. Common stock purchase options may beexercisable by the payment of cash or by other means as authorized by the Boardof Directors or a committee established by the Board of Directors. At June 30,2006, ACT had granted 1,301,161 common share purchase options under the plan.

On January 31, 2005, the Company’s Board ofDirectors approved the establishment of the 2005 Stock Incentive Plan (the “2005Plan”), subject to approval of our shareholders. The total number of commonshares available for grant and issuance under the plan may not exceed 9 millionshares, plus an annual increase on the first day of each of the Company’sfiscal years beginning in 2006 equal to 5% of the number of shares of ourcommon stock outstanding on the last day of the immediately preceding fiscalyear, subject to adjustment in the event of certain recapitalizations,reorganizations and similar transactions. Common stock purchase options may beexercisable by the payment of cash or by other means as authorized by the Boardof Directors or a committee established by the Board of Directors.

Pursuant to the 2005 Plan, on April 20, 2006, wegranted 235,000 common stock purchase options to employees and directors. Theoptions granted have an exercise price of $1.35 per share, the market price ofthe Company’s stock on the date of grant. Employee options vest monthly over aperiod of 4 years and director options were fully vested upon issue. The fairvalue of the options was estimated at $89,343 using the Black Scholes optionpricing model. The assumptions used in the Black Scholes model are as follows:(1) dividend yield of 0%; (2) expected volatility of 78%,(3) risk-free interest rate of 5.10%, and (4) expected life of6 years. The fair value was treated in accordance with FAS 123(R) and isbeing amortized over a period of four years. Since the Company vests options onthe graded method, the fair value is amortized on a straight line basis whichapproximates the vesting schedule.

Pursuant to the 2005 Plan, on January 26, 2006,we granted 230,000 common stock purchase options to employees and directors.The options granted have an exercise price of $2.04 per share, the market priceof the Company’s stock on the date of grant. Employee options vest monthly overa period of 4 years and director options were fully vested upon issue. The fairvalue of the options was estimated at $314,328 using the Black Scholes optionpricing model. The assumptions used in the Black Scholes model are as follows:(1) dividend yield of 0%; (2) expected volatility of 74%,(3) risk-free interest rate of 4.38%, and (4) expected life of 6 years.The fair value was treated in accordance with FAS 123(R) and is being amortizedover a period of four years. Since the Company vests options on the gradedmethod, the fair value is amortized on a straight line basis which approximatesthe vesting schedule.

13

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| ** **                        | ** ** | **Shares**         | ** ** | ** **             | ** ** | ** **         | ** **             | **Weighted**            | ** ** | **Weighted** | ** ** |
|-----------------------------------|------------|--------------------|------------|------------------------|------------|--------------------|------------------------|-------------------------|------------|--------------|------------|
| ** **                        | ** ** | **Available**      | ** ** | **Stock Options** | ** ** | **Price Per** | ** **             | **Average**             | ** ** | **Average**  | ** ** |
| ** **                        | ** ** | **For Grant** | ** ** | **Outstanding**        | ** ** | **Share**          | ** **             | **Exercise Price** | ** ** | **Life**     | ** ** |
| Balance at December  31, 2005     |       | 285,269            |       | 12,703,809             |       | $                  | 0.05 - $2.48 |                    | $          | 0.76         |       | 8.7 years |   |
|                              |       |               |       |                   |       |               |                   |                    |       |         |       |
| Annual increase  pursuant to plan |       | 1,172,035          |       | —                 |       | —             |                   | —                  |       | —       |       |
|                              |       |               |       |                   |       |               |                   |                    |       |         |       |
| Options granted                   |       | (230,000           | )          | 230,000                |       | $0.05              |                   | $0.05                   |       | 9.0 years    |       |
|                              |       |               |       |                   |       |               |                   |                    |       |         |       |
| Options granted                   |       | (235,000           | )          | 235,000                |       | $                  | 1.35                   |                    | $          | 1.35         |       | 9.0 years |   |
|                              |       |               |       |                   |       |               |                   |                    |       |         |       |
| Options  exercised                |       | —             |       | (20,000                | )          | $0.05              |                   | $0.05                   |       | —       |       |
|                              |       |               |       |                   |       |               |                   |                    |       |         |       |
| Options  exercised                |       | —             |       | (6,000                 | )          | $0.85              |                   | $0.85                   |       | —       |       |
|                              |       |               |       |                   |       |               |                   |                    |       |         |       |
| Balance at June 30,  2006         |       | 992,304            |       | 13,142,809             |       | $                  | .0 - $0.25   |                    | $          | 0.14         |       | 8.6 years |   |

 

Aggregate option activity for the 2004 and 2005 stockoption plans is as follows:

As of June 30, 2006 and December 31, 2005, therewere 6,525,004 and 6,320,961 exercisable options outstanding at a weightedaverage exercise price per share of $0.61 and $0.57, respectively.

Thefollowing table illustrates the effect on net income and earnings per share forthe period ended June 30, 2005 if the Company had applied the fair valuerecognition provisions of FAS 123 to options granted under the company’s stockoption plans in all periods presented. For purposes of this pro formadisclosure, the value of the options is estimated using a Black-Scholescalculation and amortized to expense over the options’ vesting periods.

|                                                 | ** ** | **For the Three  Months Ended** | ** ** | **For the Six  Months Ended** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                      | ** ** | **June 30, 2005**          | ** ** | **June 30, 2005**        | ** ** |
| Net loss as  reported                           |       | $                                    | (2,477,014 | )                                  | $          | (3,641,347 | ) |
| Current period  expense calculated under APB 25 | ** ** | **—**                           | ** ** | **—**                         | ** ** |
| Stock  compensation calculated under FAS 123    |       | 51,542                               |       | (74,939                            | )          |
| Pro forma net  loss                             |       | $                                    | (2,425,472 | )                                  | $          | (3,716,286 | ) |
| Basic and  diluted historical loss per share    |       | $                                    | (0.11      | )                                  | $          | (0.16 | ) |
| Pro forma basic and  diluted loss per share     |       | $                                    | (0.10      | )                                  | $          | (0.16 | ) |

 

The above proforma disclosures are provided for 2005 because employee stock options were notaccounted for using the fair-value method during that period.

A summary of the status of unvested employee stockoptions as of June 30, 2006 and changes during the period then ended, ispresented below:
| ** **                     | ** ** | ** **  | ** ** | **Weighted Average** | ** ** |
|--------------------------------|------------|-------------|------------|---------------------------|------------|
| ** **                     | ** ** | ** **  | ** ** | **Grant Date**       | ** ** |
| ** **                     | ** ** | ** **  | ** ** | **Fair Value**       | ** ** |
| ** **                     | ** ** | **Options** | ** ** | **Per Share**        | ** ** |
| Unvested at December  31, 2005 |       | 5,489,041   |       | $                         | 0.19       |   |
| Granted                        |       | 465,000     |       | $                         | 0.87       |   |
| Vested                         |       | (1,293,148  | )          | $                         | 0.30       |   |
| Unvested at June 30,  2006     |       | 4,660,893   |       | $                         | 0.23       |   |

 

As of June 30, 2006, the total remaining unrecognizedcompensation cost related to unvested stock options amounted to $1.2 million,which will be amortized over the weighted-average remaining requisite serviceperiod of 4.0 years.

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**7.**                 ACT GROUPSETTLEMENT

On September 14, 2005, we entered into a SettlementAgreement (“Settlement Agreement”) with Gary D. Aronson and John S. Gorton (“Plaintiffs”)and our majority shareholder, A.C.T. Group, Inc., a Delaware corporationthat has since filed a certificate of dissolution in the state of Delaware (“ACTGroup”), Advanced Cell, Inc., a Delaware Corporation, Michael D. West,Gunnar L. Engstrom, William M. Caldwell, IV, Anthem Venture Partners and GregBonfiglio (referred to collectively with the Company as the “Defendants”). TheSettlement Agreement resolved certain disputes relating to the litigationentitled *Gary D. Aronson and John Gorton v. A.C.T.Group, Inc., Advanced Cell Technology, Inc., Michael D. West, andGunnar L. Engstrom*which was pending in Commonwealth ofMassachusetts Superior Court, Worcester, C.A. No. 040523B and twocompanion Contempt Complaints filed by the Plaintiffs against certain of theDefendants, including the Company. The Settlement Agreement extinguished infull ACT Group’s obligations and indebtedness to Plaintiffs, and Plaintiffsdismissed pending claims and actions.

We analyzed the $600,000 of convertible promissorynotes payable issued by the Company in connection with this settlement, anddetermined that the conversion option and the anti-dilution provisionsrepresent embedded derivative instruments under the provisions of FAS 133,“Accounting for Derivative Instruments and Hedging Activities”. Accordingly, weseparately valued these instruments and recorded discounts offsetting NotesPayable—Other. During the three months ended June 30, 2006, a net decrease inthe fair value of the embedded derivative amounts of approximately $95,000related to these derivatives was recorded through results of operations asAdjustment to Fair Value of Derivatives.

As more fully discussed in Note 11 — SubsequentEvents, the Company repaid in full the balance of these notes and all accruedinterest subsequent to the end of the quarter.

**8.**                 LEGAL PROCEEDINGS

**Geron-Related Proceedings**

University of Massachusetts and Advanced CellTechnology, Inc. v. Roslin Institute (Edinburgh), Geron Corporation andExeter Life Sciences, Inc. , U.S. District Court for theDistrict of Columbia. We filed an action on February 18, 2005 in the U.S.District Court for the District of Columbia. We brought this action under 35U.S.C. 146 to reverse the decision of the Board of Patent Appeals andInterferences regarding a patent to a method of cloning non-human animals. Thepatent, U.S. Patent No. 5,945,577, is licensed by the University ofMassachusetts exclusively to us. The parties have engaged in discovery and areawaiting a ruling from the court on the scope of permissible discovery. Theparties are actively engaged in settlement discussions. Adverse determinationsin this proceeding would likely have a materially adverse effect on ourbusiness.

University of Massachusetts and Advanced CellTechnology, Inc. v. Roslin Institute (Edinburgh), Geron Corporation andExeter Life Sciences, Inc. , U.S. District Court for theDistrict of Columbia. We filed an action on 

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April 7, 2005 in the U.S. District Court for theDistrict of Columbia. We brought this action under 35 U.S.C. 146 to reverse thedecision of the Board of Patent Appeals and Interferences regarding a patent toa method of creating embryonic stem cells. The patent, U.S. PatentNo. 6,235,970, is licensed by the University of Massachusetts exclusivelyto us. The parties have engaged in discovery and are awaiting a ruling from thecourt on the scope of permissible discovery. The parties are actively engagedin settlement discussions. Adverse determinations in this proceeding wouldlikely have a materially adverse effect on our business.

University of Massachusetts v. James M. Robl andPhillippe Collas**,Massachusetts Superior Court (Suffolk County). The University of Massachusetts,referred to as UMass, filed a complaint on February 22, 2004 in theSuperior Court (Suffolk County) for the Commonwealth of Massachusetts. Adecision adverse to UMass in this litigation could have had a materiallyadverse effect on our business. The complaint alleged the misappropriation bythe defendants of valuable inventions in the fields of animal cloning and cellreprogramming, made by the defendants at UMass and with UMass support, that areexclusively licensed to ACT by UMass. The complaint included counts fordeclaratory judgment, breach of contract seeking specific performance,injunctive relief and damages, intentional interference with contract andprospective contractual relations, conversion, breach of duty, and breach ofthe covenant of good faith and fair dealing. ACT successfully intervened in thelitigation to protect its interests. As more fully discussed in Note 10 — Gainon Sale of Asset, in May 2006 the parties to the litigation reached asettlement agreement, and this case was dismissed during the second quarter.

**9.**                 COMMITMENTS ANDCONTINGENCIES

We are a party to a license agreement with theUniversity of Massachusetts, as amended from time to time (the “UMass License”).Under the UMass License, we were granted certain exclusive rights to licenseand sublicense certain products and services invented as part of thecollaborative effort. The term of the UMass License extends to the later of theexpiration of the related patents currently 2021, or April 16, 2006. Weare required to pay royalties ranging from 2.5% to 4.5% of net sales oflicensed products and services, as defined. Minimum royalties of $45,000 peryear must be paid to UMass. For 2005 and 2004, we have paid only the minimumroyalty required. Additionally, we are required to pay sublicense fees of 18%for sublicense income, as defined. We are required to spend a minimum annualamount of $200,000 on research and development.

In May 2006 we entered into exclusive andnon-exclusive sublicense agreements with a company whereby we are the licenseeof certain of their technology and intellectual property for a cash payment of$300,000.  The agreement requires we payminimum annual royalties of $25,000 per annum for 2006, $37,500 for 2007 and$50,000 each year thereafter through the term of the agreement.  The initial license fees paid have beencapitalized and will be amortized over the life of the underlying intellectualproperty, estimated to be approximately ten years.

In March 2006 weentered into an exclusive sublicense agreement with TranXenoGen, Inc. wherebywe are the exclusive licensee of certain of TranXenoGen’s technology andintellectual property. Pursuant to this agreement we issued 163,399 sharesof common stock with a fair value of approximately $239,000 and made a cash paymentduring the quarter of $140,000. We had previously paid $20,000 as an optionpayment related to the TranXenoGen technology. The total value paid for thislicense agreement of $399,000 has been capitalized and will be amortized overthe life of the underlying intellectual property, estimated to be approximatelyseven years.

During 2004, we entered into license agreements withtwo parties, the terms of which provide for the initial payment of the licensefee through an aggregate of six promissory notes totaling $1,400,000. The notesmature as follows: $333,333 on December 1, 2005; $666,667 onDecember 1, 2006; and $400,000 on June 1, 2007. There is no statedinterest rate for $1,000,000 of notes, the remaining $400,000 bear interest at10% per year, but only if the notes are not paid at maturity. Because of theuncertainty of the ultimate collection of the principal amount of the notes,they have not been recorded in the financial statements and will not berecorded until their collectibility is reasonable assured.

The Company entered into a lease for office andlaboratory space in Massachusetts commencing December 2004 and expiring April2010 and for office space in California commencing November 2005 and expiringMay 2008. Annual minimum lease payments are as follows:

| 2006 |   | $       | 272,774 |   |
|------|--------|---------|---------|--------|
| 2007 |   | 568,509 |    |
| 2008 |   | 386,311 |    |
| 2009 |   | 246,146 |    |
| 2010 |   | 83,400  |    |

 

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During 2005, the Company entered into a lease forlaboratory equipment commencing November 29, 2005 and expiring May 31,2008. Annual minimum lease payments are as follows:

| 2006                                      |   | $       | 43,986 |   |
|-------------------------------------------|--------|---------|--------|--------|
| 2007                                      |   | 87,972  |   |
| 2008                                      |   | 36,655  |   |
|                                      |   | 168,613 |   |
| Imputed interest                          |   | (22,581 | )      |
| Net asset value                           |   | 146,032 |   |
| Less current  portion                     |   | (77,584 | )      |
| Long-term commitment  under capital lease |   | $       | 68,448 |   |

 

Rent expense recorded in the financial statements forthe six month periods ended June 30, 2006 and 2005 was $416,348 and $219,388,respectively.

We have entered into employment contracts with certainexecutives and research personnel. The contracts provide for salaries, bonusesand stock option grants, along with other employee benefits. The employmentcontracts generally have no set term and can be terminated by either party.There is a provision for payments of three months to one year of annual salaryas severance if we terminate a contract without cause, along with theacceleration of certain unvested stock option grants.

**10.**          GAIN ON SALE OF ASSET

In May 2006, the Company sold a minority interest itowned in an entity for cash proceeds of approximately $767,000, resulting in aGain on Sale of Asset as the Company had no asset value recorded for itsinvestment. As part of this sale, the Company entered into a series ofagreements that resolved certain legal matters described more fully in Note 8 —Legal Proceedings under *University ofMassachusetts v. James M. Robl and Phillippe Collas* and the case was dismissed. 

**11.   SUBSEQUENT EVENTS**

In July and August 2006, the Company madeits monthly redemptions of convertible debentures described in Note 3. Theterms of the agreement provide for payment in cash, or company stock undercertain circumstances. In connection with the July redemption, the Company paidcash of approximately $328,000 and issued approximately 690,000 shares ofcommon stock. At June 30, 2006, approximately 33,000 of the shares related tothe July redemption had been preliminarily issued by the transfer agent inaccordance with the terms of the debenture agreement. Such shares are notreflected as issued and outstanding by the company prior to finalizing shareand cash payments in connection with the redemption in July 2006. Inconnection with the August redemption, the Company paid cash ofapproximately $429,000 and issued approximately 747,000 shares.

Subsequent to June 30, 2006 the Company repaid$600,000 of convertible notes payable described more fully in Note 7 — ACTGroup Settlement. This cash payment, along with accrued interest and costs,resulted in payment in full of the outstanding notes payable balances. 

In consideration for service on the Company’s Board ofDirectors and Audit Committee, the Company issued to Dr. Alan Shapiro 44,216shares of Common Stock in July 2006.

 

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** **

**ITEM 2.   MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

**OVERVIEW**

This Quarterly Report on Form 10-QSBcontains forward-looking statements that involve risks and uncertainties. Weuse words such as “may,” “assumes,” “forecasts,” “positions,” “predicts,” “strategy,”“will,” “expects,” “estimates,” “anticipates,” “believes,” “projects,” “intends,”“plans,” “budgets,” “potential,” “continue” and variations thereof, and otherstatements contained in quarterly report, and the exhibits hereto, regardingmatters that are not historical facts and are forward-looking statements.Because these statements involve risks and uncertainties, as well as certainassumptions, actual results may differ materially from those expressed orimplied by such forward-looking statements. Factors that could cause actualresults to differ materially include, but are not limited to risks inherent in:our early stage of development, including a lack of operating history, lack ofprofitable operations and the need for additional capital; the development andcommercialization of largely novel and unproven technologies and products; ourability to protect, maintain, and defend our intellectual property rights:uncertainties regarding our ability to obtain the capital resources needed tocontinue research and development operations and to conduct research,preclinical development and clinical trials necessary for regulatory approvals;uncertainty regarding the outcome of clinical trials and our overall ability tocompete effectively in a highly complex, rapidly developing, capital intensiveand competitive industry. See “RISK FACTORS THAT MAY AFFECT OUR BUSINESS”**set forth below on page 23 for a morecomplete discussion of these factors. Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datethat they are made. We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise.

The following discussion should be read in conjunctionwith the financial statements and notes thereto included in Part I, Item 1of this Quarterly Report on Form 10-QSB.

We are a biotechnology company focused on developingand commercializing human stem cell technology in the emerging fields ofregenerative medicine and stem cell therapy.

**SIGNIFICANT ACCOUNTING POLICIES**

Our financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America. The preparation of these financial statements requires managementto make estimates and assumptions that affect the reported amounts of assets,liabilities, revenues and expenses. Note 2 of the Notes to Financial Statementsdescribes the significant accounting policies used in the preparation of thefinancial statements. Certain of these significant accounting policies areconsidered to be critical accounting policies, as defined below. We do notbelieve that there have been significant changes to our accounting policiesduring the six months ended June 30, 2006, as compared to those policiesdisclosed in the December 31, 2005 financial statements filed in ourAnnual Report on Form 10-KSB with the SEC on March 31, 2006.

A critical accounting policy is defined as one that isboth material to the presentation of our financial statements and requiresmanagement to make difficult, subjective or complex judgments that could have amaterial effect on our financial condition and results of operations.Specifically, critical accounting estimates have the following attributes: 1)we are required to make assumptions about matters that are highly uncertain atthe time of the estimate; and 2) different estimates we could reasonably haveused, or changes in the estimate that are reasonably likely to occur, wouldhave a material effect on our financial condition or results of operations.

Estimates and assumptions about future events andtheir effects cannot be determined with certainty. We base our estimates onhistorical experience and on various other assumptions believed to beapplicable and reasonable under the circumstances. These estimates may changeas new events occur, as additional information is obtained and as our operatingenvironment changes. These changes have historically been minor and have beenincluded in the financial statements as soon as they became known. Based on acritical assessment of our accounting policies and the underlying judgments anduncertainties affecting the application of those policies, management believesthat our financial statements are fairly stated in accordance with accountingprinciples generally accepted in the United States, and present a meaningfulpresentation of our financial condition and results of operations. We believethe 

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following critical accounting policies reflect ourmore significant estimates and assumptions used in the preparation of ourfinancial statements:

***Use of Estimates—***Thesefinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States and, accordingly, requiremanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the reporting period.Specifically, our management has estimated the expected economic life and valueof our licensed technology, our net operating loss for tax purposes and ourstock, option and warrant expenses related to compensation to employees and directors,consultants and investment banks. Actual results could differ from thoseestimates.

***Fair Value ofFinancial Instruments—***For certain of our financialinstruments, including accounts receivable, accounts payable, accrued expenses,interest payable, bank overdraft, advances payable and notes payable, thecarrying amounts approximate fair value due to their relatively shortmaturities.

***Valuation ofDerivative Instruments***—These financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States and, accordingly, require management to make estimates andassumptions that affect the reported amounts of assets and liabilities at thedate of the financial statements and the reported amounts during the reportingperiods. Specifically, FAS 133, “Accounting for Derivative Instruments andHedging Activities” requires bifurcation of embedded derivative instruments andmeasurement of fair value for accounting purposes. In determining theappropriate fair value, the Company uses a variety of valuation techniquesincluding Black Scholes models, Binomial Option Pricing models, Standard PutOption Binomial models and net present value of certain penalty amounts.Derivative liabilities are adjusted to reflect fair value at each period end,with any increase or decrease in the fair value being recorded in results ofoperations as Adjustments to Fair Value of Derivatives. In addition, the fairvalue of freestanding derivative instruments such as warrant derivatives are valuedusing Black Scholes models.

***Cash andEquivalents—***Cash equivalents are comprised of certain highlyliquid investments with maturity of three months or less when purchased. Wemaintain our cash in bank deposit accounts, which at times, may exceed federallyinsured limits. We have not experienced any losses in such account.

***Equipment—***Werecord our equipment at historical cost. We expense maintenance and repairs asincurred. Depreciation is provided for by the straight-line method over threeto six years.

***Revenue Recognition—***Ourrevenues are generated from license and research agreements with collaborators.Licensing revenue is recognized ratably over the life of the license. Deferredrevenue represents the portion of the license and other payments received thathas not been earned. Costs associated with the license revenue are deferred andrecognized over the same term as the revenue. Reimbursements of researchexpense pursuant to grants are recorded as a reduction of research anddevelopment expense once the reimbursements are approved and the Company isassured of collectibility.

***Intangible andLong-Lived Assets—***We follow SFAS No. 144, “*Accounting for Impairment of Disposal of Long-LivedAssets*”, whichestablished a “primary asset” approach to determine the cash flow estimationperiod for a group of assets and liabilities that represents the unit ofaccounting for a long lived asset to be held and used. Long-lived assets to beheld and used are reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. The carrying amount of a long-lived asset is not recoverable if itexceeds the sum of the undiscounted cash flows expected to result from the useand eventual disposition of the asset. Long-lived assets to be disposed of arereported at the lower of carrying amount or fair value less cost to sell.During the period ended June 30, 2006 no impairment losses were recognized.

***Research andDevelopment Costs—***Research and development costs consistof expenditures for the research and development of patents and technology,which are not capitalizable. Our research and development costs consist mainlyof payroll and payroll related expenses, research supplies and costs incurredin connection with specific research grants.

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***Stock BasedCompensation—***SFAS No. 123, “*Accounting for Stock-Based Compensation*,”establishes and encourages the use of the fair value based method of accountingfor stock-based compensation arrangements under which compensation cost isdetermined using the fair value of stock-based compensation determined as ofthe date of the grant or the date at which the performance of the services iscompleted and is recognized over the periods in which the related services arerendered.

The Company uses the fair value method for equityinstruments granted to non-employees and uses the Black Scholes model formeasuring the fair value. The stock based fair value compensation is determinedas of the date of the grant or the date at which the performance of theservices is completed (measurement date) and is recognized over the periods inwhich the related services are rendered.

At June 30, 2006, the Company has two stock-basedemployee compensation plans, which are described more fully in Note 6. Prior toJanuary 1, 2006, the Company accounted for those plans under therecognition and measurement provisions of APB Opinion No. 25, Accountingfor Stock Issued to Employees, and related Interpretations, as permitted by FASStatement No. 123, Accounting for Stock-Based Compensation. No stock-basedemployee compensation cost was recognized in the Statement of Operations forthe years ended December 31, 2005 or 2004, as all options granted underthose plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant.

Effective January 1,2006, the Company adopted the fair value recognition provisions of FASStatement No. 123(R) Share-Based Payment, using themodified-prospective-transition method. Under that transition method,compensation cost recognized in the six months ended June 30, 2006 includes:(a) compensation cost for all share-based payments granted prior to, butnot yet vested as of January 1, 2006, based on the grant date fair valueestimated in accordance with the original provisions of FAS 123, and(b) compensation cost for all share-based payments granted subsequent toJanuary 1, 2006, based on the grant-date fair value estimated inaccordance with the provisions of FAS 123(R). Results for prior periods havenot been restated.

**RESULTS OF OPERATIONS**

***Revenues***

Revenues for the three and six months ended June, 2006and 2005 were approximately $121,000, $204,000, $121,000 and $229,000respectively. These amounts relate primarily to license fees and royaltiescollected that are being amortized over the period of the license granted. Thereduction in revenue in current periods was due to decreased revenue levelsfrom licensees’ operations.

***Research andDevelopment Expenses and Grant Reimbursements***

Research and development expenses for the three andsix months ended June 30, 2006 and 2005 were approximately $2,617,000,$4,426,000, $657,000 and $934,000, respectively. The increase in expenses in thecurrent periods, which consist mainly of facility costs, payroll and payrollrelated expenses, research supplies and costs incurred in connection withspecific research grants, relate principally to increased staffing and spendingfor scientific research.

Our research and development expenses consistprimarily of costs associated with basic and pre-clinical research exclusivelyin the field of human stem cell therapies and regenerative medicine, with focuson development of our technologies in cellular reprogramming, reducedcomplexity applications, and stem cell differentiation. These expensesrepresent both pre-clinical development costs and costs associated withnon-clinical support activities such as quality control and regulatoryprocesses. The cost of our research and development personnel is the mostsignificant category of expense; however, we also incur expenses with thirdparties, including license agreements, sponsored research programs andconsulting expenses.

We do not segregate research and development costs byproject because our research is focused exclusively on human stem celltherapies as a unitary field of study. Although we have three principal areasof focus for our research, these areas are completely intertwined and have notyet matured to the point where they are separate and distinct projects. Theintellectual property, scientists and other resources dedicated to theseefforts are not separately allocated to individual projects, but rather areconducting our research on an integrated basis.

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We expect that research and development expenses willcontinue to increase in the foreseeable future as we add personnel, expand ourpre-clinical research, begin clinical trial activities, and increase ourregulatory compliance capabilities. The amount of these increases is difficultto predict due to the uncertainty inherent in the timing and extent of progressin our research programs, and initiation of clinical trials. In addition, theresults from our basic research and pre-clinical trials, as well as the resultsof trials of similar therapeutics under development by others, will influencethe number, size and duration of planned and unplanned trials. As our researchefforts mature, we will continue to review the direction of our research basedon an assessment of the value of possible commercial applications emerging fromthese efforts. Based on this continuing review, we expect to establish discreteresearch programs and evaluate the cost and potential for cash inflows fromcommercializing products, partnering with others in the biotechnology orpharmaceutical industry, or licensing the technologies associated with theseprograms to third parties.

We believe that it is not possible at this stage toprovide a meaningful estimate of the total cost to complete our ongoingprojects and bring any proposed products to market. The use of human embryonicstem cells as a therapy is an emerging area of medicine, and it is not knownwhat clinical trials will be required by the FDA in order to gain marketingapproval. Costs to complete could vary substantially depending upon theprojects selected for development, the number of clinical trials required andthe number of patients needed for each study. It is possible that thecompletion of these studies could be delayed for a variety of reasons, includingdifficulties in enrolling patients, delays in manufacturing, incomplete orinconsistent data from the pre-clinical or clinical trials, and difficultiesevaluating the trial results. Any delay in completion of a trial would increasethe cost of that trial, which would harm our results of operations. Due tothese uncertainties, we cannot reasonably estimate the size, nature nor timingof the costs to complete, or the amount or timing of the net cash inflows fromour current activities. Until we obtain further relevant pre-clinical andclinical data, we will not be able to estimate our future expenses related tothese programs or when, if ever, and to what extent we will receive cashinflows from resulting products .

Grant reimbursements for the three and six monthsended June 30, 2006 and 2005 were approximately $163,000, $364,000, $189,000and $425,000, respectively. These amounts represent approved reimbursementspursuant the grant from NIST. This grant expired in May 2006.

***General andAdministrative Expenses***

General and administrative expenses for the three andsix months ended June 30, 2006 and 2005 were approximately $1,878,000,$4,508,000, $2,037,000 and $3,242,000, respectively. The principal increase inexpense in the six month period versus the same period last year is a result ofadditional salary costs related to the addition of key personnel andapproximately $600,000 of costs incurred by the Company for investor relationsrelated expenses during the current period. Expenses for the three month periodversus the same period last year are down modestly, primarily as a result ofreduced general and administrative infrastructure costs and legal fees.

***Other Income (Expense)***

Other income (expense) for the three and six monthsended June 30, 2006 and 2005 were approximately $13,599,000, $22,628,000,($35,000) and ($16,000), respectively. The increase in other income in thethree and six months ended June 30, 2006, compared to other expense in theprior periods, relates primarily adjustments to fair value of derivativesrelated to the Convertible Debenture financing. The increase in interestexpense and late fees in the three and six months ended June 2006,compared to interest expense in the prior periods relates primarily to interestrecorded in connection with the convertible debentures.

***Net Profit / ( Loss )***

Net profit / (loss) for the three and six months endedJune 30, 2006 and 2005 was approximately $9,295,000, $14,108,000, ($2,477,000)and ($3,641,000), respectively. The increase in profit in the current period isthe result of changes to the fair value of derivatives, partially offset byincreased general and administrative and research and development expenses.

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***Recent AccountingPronouncements***

In February 2006, the FASB issued FASB StatementNo. 155, Accounting for Certain Hybrid Instruments. This standard amendsthe guidance in FASB Statements No. 133, Accounting for DerivativeInstruments and Hedging Activities, and No. 140, Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities. Statement155 allows financial instruments that have embedded derivatives to be accountedfor as a whole (eliminating the need to bifurcate the derivative from its host)if the holder elects to account for the whole instrument on a fair value basis.

Management has adopted FASB Statement No. 155 andwill apply it to all future transactions as applicable.

***LIQUIDITY ANDCAPITAL RESOURCES***

We are financing our operations primarily with$17,750,000 of proceeds of convertible debentures issued September 15,2005 and described in our Current Report on Form 8-K filed with theSecurities and Exchange Commission on September 19, 2005, and $8,000,000of proceeds from a January 2005 preferred unit offering. To asubstantially lesser degree, financing of our operations is provided throughgrant funding, payments received under license agreements, and interest earnedon cash and cash equivalents.

With the exception of 2002, when we sold certainassets of a subsidiary resulting in a gain for the year, we have incurredsubstantial net losses each year since inception as a result of research anddevelopment and general and administrative expenses in support of ouroperations. We anticipate incurring substantial net losses in the future.

Cash and cash equivalents at June 30, 2006 andDecember 31, 2005 were approximately $5,300,000 and $13,900,000,respectively. The decrease in the current period is primarily the result ofcash utilized in operations, capital expenditures, and $500,000 of costs incurredby the Company for investor relations related expenses in the current period.

Our cash and cash equivalents are limited. We expectto require substantial additional funding. Our future cash requirements willdepend on many factors, including the pace and scope of our research anddevelopment programs, the costs involved in filing, prosecuting, maintainingand enforcing patents and other costs associated with commercializing ourpotential products. We intend to seek additional funding primarily throughpublic or private 

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financing transactions, and, to a lesser degree, newlicensing or scientific collaborations, grants from governmental or otherinstitutions, and other related transactions. If we are unable to raiseadditional funds, we will be forced to either scale back our business effortsor curtail our business activities entirely. We anticipate that our availablecash and expected income will be sufficient to finance most of our currentactivities for at least twelve months from the date of the financial statements,although certain of these activities and related personnel may need to bereduced. We cannot assure you that public or private financing or grants willbe available on acceptable terms, if at all. Several factors will affect ourability to raise additional funding, including, but not limited to, thevolatility of our Common Stock.

**RISKFACTORS THAT MAY AFFECT OUR BUSINESS**

*Our business issubject to various risks, included but not limited to those described below.You should carefully consider these factors, together with all the otherinformation disclosed in this Quarterly Report on Form 10-QSB. Anyof these risks could materially adversely affect our business, operatingresults and financial condition.*

**Risks Relating to Our Early Stage of Development**

**We have a limitedoperating history on which potential investors may evaluate our operationsand prospects for profitable operations**.   We have a limited operating history on whicha potential investor may base an evaluation of us and our prospects. If weare unable to begin and sustain profitable operations, investors may losetheir entire investment in us. We are in the pre-clinical stage, and ourprospects must be considered speculative in light of the risks, expenses anddifficulties frequently encountered by companies in their early stages ofdevelopment, particularly in light of the uncertainties relating to the new,competitive and rapidly evolving markets in which we anticipate we willoperate. To attempt to address these risks, we must, among other things,further develop our technologies, products and services, successfully implementour research, development, marketing and commercialization strategies, respondto competitive developments and attract, retain and motivate qualifiedpersonnel. A substantial risk is involved in investing in us because, as adevelopment stage company,

·                                          wehave fewer resources than an established company,

·                                          ourmanagement may be more likely to make mistakes at such an early stage, and

·                                          wemay be more vulnerable operationally and financially to any mistakes thatmay be made, as well as to external factors beyond our control.

These difficulties are compounded by our heavydependence on emerging and sometimes unproven technologies. In addition, someof our significant potential revenue sources involve ethically sensitive andcontroversial issues which could become the subject of legislation orregulations that could materially restrict our operations and, therefore, harmour financial condition, operating results and prospects for bringing ourinvestors a return on their investment.

**We have a history ofoperating losses, and we cannot assure you that we will achieve future revenuesor operating profits**.   Wehave generated modest revenue to date from our operations. Historically, wehave had net operating losses each year since our inception. We have limitedcurrent potential sources of revenue from license fees and product developmentrevenues, and we cannot assure you that we will be able to develop such revenuesources or that our operations will become profitable, even if we are able tocommercialize our technologies or any products or services developed from thosetechnologies. If we continue to suffer losses as we have in the past, investorsmay not receive any return on their investment and may lose theirentire investment.

Although we have revenues from license fees androyalties, we have no commercially marketable products and no immediate abilityto generate revenue from commercial products, nor any assurance of being ableto develop our technologies for commercial applications. As a result, wemay never be able to operate profitably. We are just beginning to identifyproducts available for pre-clinical trials and may not receive significantrevenues from commercial sales of our products for the next several years, ifat all, although we do generate revenues from licensing activities. We havemarketed only a limited amount of services based on our technologies and havelittle 

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experience in doing so. Our technologies and anypotential products or services that we may develop will requiresignificant additional effort and investment prior to materialcommercialization and, in the case of any biomedical products, pre-clinical andclinical testing and regulatory approvals. We cannot assure you that we will beable to develop any such technologies or any products or services, or that suchtechnologies, products or services will prove to be safe and efficacious inclinical trials, meet applicable regulatory standards, be capable of beingproduced in commercial quantities at acceptable costs or be successfullymarketed. For that reason, we may not be able to generate revenues fromcommercial production or operate profitably.

We have sold the agricultural portion of our businessin order to finance operations. The agricultural applications of our technologygenerally have a more rapid realization of revenues due to more limitedregulatory requirements and testing. Our ability to generate revenue from anyagricultural applications of our technology is limited to existing licenseroyalties, if any.

**We will requiresubstantial additional funds to continue operating which may not beavailable on acceptable terms, if at all.  **We have losses from operations, negative cash flowsfrom operations and a substantial stockholders’ deficit that raise substantialdoubt about the Company’s ability to continue as a going concern. We do notbelieve that our cash from all sources, including cash, cash equivalents andanticipated revenue stream from licensing fees and sponsored research contractsis sufficient for us to continue operations through June 30, 2007 withoutraising additional financing.

Management continues to evaluate alternatives andsources for additional funding, which may include public or private investors,strategic partners, and grant programs available through specific states orfoundations, although there is no assurance that such sources will result inraising additional capital. Lack of necessary funds may require us to delay,scale back or eliminate some or all of our research and product developmentprograms and/or our capital expenditures, to license our potential products ortechnologies to third parties, to consider business combinations related toongoing business operations, or shut down some, or all, of our operations.

In addition, our cash requirements may varymaterially from those now planned because of results of research anddevelopment, potential relationships with strategic partners, changes in thefocus and direction of our research and development programs, competition,litigation required to protect our technology, technological advances, the costof pre-clinical and clinical testing, the regulatory process of the UnitedStates Food and Drug Administration, or FDA, and foreign regulators, whetherany of our products become approved or the market acceptance of any suchproducts and other factors. Our current cash reserves are not sufficient to fundour operations through the commercialization of our first products or services.

**We have limitedclinical testing, regulatory, manufacturing, marketing, distribution and salescapabilities which may limit our ability to generate revenues**.   Because of the relatively early stage of ourresearch and development programs, we have not yet invested significantly inclinical testing, regulatory, manufacturing, or in marketing, distribution orproduct sales resources. We cannot assure you that we will be able to developany such resources successfully or as quickly as may be necessary. Theinability to do so may harm our ability to generate revenues or operateprofitably.

**Risks Relating to Competition**

**Our competitionincludes both public and private organizations and collaborations amongacademic institutions and large pharmaceutical companies, most of which havesignificantly greater experience and financial resources than we do**.   The biotechnology and pharmaceuticalindustries are characterized by intense competition. We compete againstnumerous companies, both domestic and foreign, many of which have substantiallygreater experience and financial and other resources than we have. Several suchenterprises have initiated cell therapy research programs and/or efforts totreat the same diseases targeted by us. Companies such as Geron Corporation,Genzyme Corporation, StemCells, Inc., Aastrom Biosciences, Inc. andViacell, Inc., as well as others, many of which have substantially greaterresources and experience in our fields than we do, are well situated to competewith us effectively. Of course, any of the world’s largest pharmaceuticalcompanies represents a significant actual or potential competitor with vastlygreater resources than ours.

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These companies hold licenses to genetic selectiontechnologies and other technologies that are competitive with our technologies.These and other competitive enterprises have devoted, and will continue todevote, substantial resources to the development of technologies and productsin competition with us.

Private and public academic and research institutionsalso compete with us in the research and development of human therapeutic oragricultural products. In the past several years, the pharmaceutical industryhas selectively entered into collaborations with both public and privateorganizations to explore the possibilities that stem cell therapiesmay present for substantive breakthroughs in the fight against disease.

In addition, many of our competitors havesignificantly greater experience than we have in the development, pre-clinicaltesting and human clinical trials of biotechnology and pharmaceutical products,in obtaining FDA and other regulatory approvals of such products and inmanufacturing and marketing such products. Accordingly our competitorsmay succeed in obtaining FDA approval for products more rapidly oreffectively than we can. Our competitors may also be the first to discoverand obtain a valid patent to a particular stem cell which may effectivelyblock all others from doing so. It will be important for us or ourcollaborators to be the first to discover any stem cell that we are seeking todiscover. Failure to be the first could prevent us from commercializing all ofour research and development affected by that discovery. Additionally, if wecommence commercial sales of any products, we will also be competing withrespect to manufacturing efficiency and sales and marketing capabilities, areasin which we have no experience.

The United States is encountering tremendouscompetition from many foreign countries that are providing an environment moreattractive for stem cell research. The governments of numerous foreigncountries are investing in stem cell research, providing facilities, personneland legal environments intended to attract biotechnology companies andencourage stem cell research and development of stem cell-related technologies.

These efforts by foreign countries may make itmore difficult to effectively compete in our industry and may generatecompetitors with substantially greater resources than ours.

**Risks Relating to Our Technology**

**We rely on nucleartransfer and embryonic stem cell technologies that we may not be able tosuccessfully develop, which will prevent us from generating revenues, operatingprofitably or providing investors any return on their investment**.   We have concentrated our research on ournuclear transfer and embryonic stem cell technologies, and our ability tooperate profitably will depend on being able to successfully develop thesetechnologies for human applications. These are emerging technologies with, asyet, limited human applications. We cannot guarantee that we will be able tosuccessfully develop our nuclear transfer and embryonic stem cell technologiesor that such development will result in products or services with anysignificant commercial utility. We anticipate that the commercial sale of suchproducts or services, and royalty/licensing fees related to our technology,would be our primary sources of revenues. If we are unable to develop ourtechnologies, investors will likely lose their entire investment in us.

The outcome of pre-clinical, clinical and producttesting of our products is uncertain, and if we are unable to satisfactorilycomplete such testing, or if such testing yields unsatisfactory results, wewill be unable to commercially produce our proposed products. Before obtainingregulatory approvals for the commercial sale of any potential human products,our products will be subjected to extensive pre-clinical and clinical testingto demonstrate their safety and efficacy in humans. We cannot assure you thatthe clinical trials of our products, or those of our licensees orcollaborators, will demonstrate the safety and efficacy of such products atall, or to the extent necessary to obtain appropriate regulatory approvals, orthat the testing of such products will be completed in a timely manner, if atall, or without significant increases in costs, program delays or both, all ofwhich could harm our ability to generate revenues. In addition, our prospectiveproducts may not prove to be more effective for treating disease or injurythan current therapies. Accordingly, we may have to delay or abandonefforts to research, develop or obtain regulatory approval to market ourprospective products. Many companies involved in biotechnology research anddevelopment have suffered significant setbacks in advanced clinical trials,even after promising results in earlier trials. The failure to adequatelydemonstrate the safety and efficacy of a therapeutic product under development

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could delay or prevent regulatory approval of theproduct and could harm our ability to generate revenues, operate profitably orproduce any return on an investment in us.

While the marketing of cloned or transgenic animalsdoes not currently require regulatory approval, such approval may berequired in the future. We cannot assure you that we would obtain suchapprovals or that our licensees’ products would be accepted in the marketplace.This lack of approval could reduce or preclude any royalty revenues we mightreceive from our licensees in that field.

**We may not beable to commercially develop our technologies and proposed product lines,which, in turn, would significantly harm our ability to earn revenues andresult in a loss of investment**.   Ourability to commercially develop our technologies will be dictated in largepart by forces outside our control which cannot be predicted, including,but not limited to, general economic conditions, the success of our researchand pre-clinical and field testing, the availability of collaborative partnersto finance our work in pursuing applications of nuclear transfer technology andtechnological or other developments in the biomedical field which, due toefficiencies, technological breakthroughs or greater acceptance in thebiomedical industry, may render one or more areas of commercializationmore attractive, obsolete or competitively unattractive. It is possible thatone or more areas of commercialization will not be pursued at all if a collaborativepartner or entity willing to fund research and development cannot be located.Our decisions regarding the ultimate products and/or services we pursue couldhave a significant adverse affect on our ability to earn revenue if wemisinterpret trends, underestimate development costs and/or pursue wrongproducts or services. Any of these factors either alone or in concert couldmaterially harm our ability to earn revenues and could result in a loss of anyinvestment in us.

**If we are unableto keep up with rapid technological changes in our field or competeeffectively, we will be unable to operate profitably.  **We are engaged in activities in the biotechnologyfield, which is characterized by extensive research efforts and rapidtechnological progress. If we fail to anticipate or respond adequately totechnological developments, our ability to operate profitably could suffer. Wecannot assure you that research and discoveries by other biotechnology,agricultural, pharmaceutical or other companies will not render our technologiesor potential products or services uneconomical or result in products superiorto those we develop or that any technologies, products or services we developwill be preferred to any existing or newly-developed technologies, products orservices.

**We may not be able toprotect our proprietary technology, which could harm our ability to operateprofitably**.   The biotechnology andpharmaceutical industries place considerable importance on obtaining patent andtrade secret protection for new technologies, products and processes. Oursuccess will depend, to a substantial degree, on our ability to obtain andenforce patent protection for our products, preserve any trade secrets andoperate without infringing the proprietary rights of others. We cannot assureyou that:

·                                          wewill succeed in obtaining any patents in a timely manner or at all, or that thebreadth or degree of protection of any such patents will protect our interests,

·                                          theuse of our technology will not infringe on the proprietary rights of others,

·                                          patentapplications relating to our potential products or technologies will result inthe issuance of any patents or that, if issued, such patents will affordadequate protection to us or not be challenged invalidated or infringed, and

·                                          patentswill not issue to other parties, which may be infringed by our potentialproducts or technologies.

We are aware of certain patents that have been grantedto others and certain patent applications that have been filed by others withrespect to nuclear transfer technologies. The fields in which we operate havebeen characterized by significant efforts by competitors to establish dominantor blocking patent rights to gain a competitive advantage, and by considerabledifferences of opinion as to the value and legal legitimacy of competitors’purported patent rights and the technologies they actually utilize in theirbusinesses.

**Our business is highlydependent upon maintaining licenses with respect to key technology**.   Several of the key patents we utilize are licensedto us by third parties. These licenses are subject to termination under certain

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circumstances (including, for example, our failure tomake minimum royalty payments or to timely achieve development and commercializationbenchmarks). The loss of any of such licenses, or the conversion of suchlicenses to non-exclusive licenses, could harm our operations and/or enhancethe prospects of our competitors.

Certain of these licenses also contain restrictions,such as limitations on our ability to grant sublicenses that could materiallyinterfere with our ability to generate revenue through the licensing or sale tothird parties of important and valuable technologies that we have, forstrategic reasons, elected not to pursue directly. The possibility exists thatin the future we will require further licenses to complete and/or commercializeour proposed products. We cannot assure you that we will be able to acquire anysuch licenses on a commercially viable basis.

**We may not be able toadequately protect against piracy of intellectual property in foreignjurisdictions.  **Considerableresearch in the areas of stem cells, cell therapeutics and regenerativemedicine is being performed in countries outside of the United States, and anumber of our competitors are located in those countries. The laws protectingintellectual property in some of those countries may not provideprotection for our trade secrets and intellectual property adequate to preventour competitors from misappropriating our trade secrets or intellectualproperty. If our trade secrets or intellectual property are misappropriated inthose countries, we may be without adequate remedies to address the issue.

**Certain of our technology isnot protectable by patent**.   Certainparts of our know-how and technology are not patentable. To protect ourproprietary position in such know-how and technology, we intend to require allemployees, consultants, advisors and collaborators to enter intoconfidentiality and invention ownership agreements with us. We cannot assureyou, however, that these agreements will provide meaningful protection for ourtrade secrets, know-how or other proprietary information in the event of anyunauthorized use or disclosure. Further, in the absence of patent protection,competitors who independently develop substantially equivalent technologymay harm our business.

**Patent litigation presentsan ongoing threat to our business with respect to both outcomes and costs.  **We have previously been involved in patentinterference litigation with Infigen, Inc., and are currently involved intwo patent disputes with Geron Corporation, and it is possible that furtherlitigation over patent matters with one or more competitors could arise. Wecould incur substantial litigation or interference costs in defending ourselvesagainst suits brought against us or in suits in which we may assert ourpatents against others. If the outcome of any such litigation, including ourcurrent disputes with Geron Corporation, is unfavorable, our business wouldlikely be materially adversely affected. To determine the priority ofinventions, we may also have to participate in interference proceedingsdeclared by the United States Patent and Trademark Office, which could resultin substantial cost to us. Without additional capital, we may not have theresources to adequately defend or pursue this litigation.

**Risks Relating to the September 2005 Financing**

**If we are requiredfor any reason to repay our outstanding convertible debentures we would berequired to deplete our working capital, if available, or raise additionalfunds. Our failure to repay the convertible debentures, if required, couldresult in legal action against us, which could require the sale of substantialassets.  **We haveoutstanding, as of August 4, 2006, $16,768,500 aggregate original principalamount of convertible debentures with an original issue discount of 20.3187%.Beginning on March 14, 2006, and continuing for each successive monththroughout the three year term of the debentures, we are required to redeem, bypayment with cash or with shares of our common stock, 1/30th of the aggregateoriginal principal amount of the debentures. Unless waived by the holders ofthe debentures, in order to redeem with shares of our common stock we mustsatisfy certain conditions which have yet to be satisfied, including suchconditions as the listing of our shares of common stock on either the NASDAQNational Market, the NASDAQ Small Cap Market, or the American Stock Exchange.These monthly payments will impact the amount of working capital available tous. The convertible debentures are due and payable on September 14, 2008,unless sooner converted into shares of our common stock. Any event of defaultcould require the early repayment of the convertible debentures, including theaccruing of interest on the outstanding principal balance of the debentures ifthe default is not cured with the specified grace period. We anticipate thatthe full amount of the convertible debentures will be converted into shares ofour common stock, in accordance with the terms of the convertible debentures.If, prior to the maturity date, we are required to repay the convertibledebentures in full, we would be required to use our limited working capital andraise additional funds. If we were unable to

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repay the notes when required, the debenture holderscould commence legal action against us to recover the amounts due. Any suchaction could require us to curtail or cease operations.

There are a large number of shares underlying ourconvertible debentures in full, and warrants that are registered and availablefor sale and the sale of these shares may depress the market price of ourcommon stock. As of August 4, 2006, we had:

·                                          outstandingconvertible debentures that may be converted into an estimated 7,290,652shares of common stock based on a conversion price of $2.30, and

·                                          outstandingwarrants to purchase 6,004,902 shares of common stock with an exercise price of$2.53, that were issued in connection with the sale of the convertibledebentures.

Sales of a substantial number of shares of our commonstock in the public market could adversely affect the market price for ourcommon stock and make it more difficult for you to sell shares of our commonstock at times and prices that you feel are appropriate.

**The issuance ofshares upon conversion of the convertible debentures and exercise ofoutstanding warrants will cause immediate and substantial dilution to ourexisting stockholders.  **Theissuance of shares upon conversion of the convertible debentures and exerciseof warrants will result in substantial dilution to the interests of otherstockholders since the selling security holders may ultimately convert andsell the full amount issuable on conversion. Although no single sellingsecurity holder may convert its convertible debentures and/or exercise itswarrants if such conversion or exercise would cause it to own more than 4.99%of our outstanding common stock, this restriction does not prevent each sellingsecurity holder from converting and/or exercising some of its holdings and thenconverting the rest of its holdings. In this way, each selling security holdercould sell more than this limit while never holding more than this limit. Thereis no upper limit on the number of shares that may be issued which willhave the effect of further diluting the proportionate equity interest andvoting power of holders of our common stock, including investors in thisoffering.

**Payment of mandatorymonthly redemptions in shares of common stock will result in substantialdilution.  **We expect tosatisfy all or a significant portion of our obligation to redeem 1/30th of theaggregate original principal amount of debentures per month beginning March2006 through issuance of additional shares of our common stock. This approachwill result in substantial dilution to the interests of other stockholders.

**Risks Relating to Government Regulation**

**Companies such asours engaged in research using nuclear transfer and embryonic stem cells arecurrently subject to strict government regulations, and our operations could beharmed by any legislative or administrative efforts impacting the use ofnuclear transfer technology or human embryonic material.  **Our business is focused on human cell therapy, whichincludes the production of human differentiated cells from stem cells andinvolves the use of nuclear transfer technology, human oocytes, and embryonicmaterial. Nuclear transfer technology, commonly known as therapeutic cloning,and research utilizing embryonic stem cells are controversial subjects, and arecurrently subject to intense scrutiny, both in the United States, the UnitedNations and throughout the world, particularly in the area of nuclear transferof human cells and the use of human embryonic material.

We cannot assure you that our operations will not beharmed by any legislative or administrative efforts by politicians or groupsopposed to the development of nuclear transfer technology generally or the useof nuclear transfer for therapeutic cloning of human cells specifically.Further, we cannot assure you that legislative or administrative restrictionsdirectly or indirectly delaying, limiting or preventing the use of nucleartransfer technology or human embryonic material or the sale, manufacture or useof products or services derived from nuclear transfer technology or humanembryonic material will not be adopted in the future.

**Restrictions onthe use of human embryonic stem cells, and the ethical, legal and socialimplications of that research, could prevent us from developing or gainingacceptance for commercially viable products in these areas**.   Some of our most important programs involvethe use of stem cells that are derived from human

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embryos. The use of human embryonic stem cells givesrise to ethical, legal and social issues regarding the appropriate use of thesecells. In the event that our research related to human embryonic stem cellsbecomes the subject of adverse commentary or publicity, the market price forour common stock could be significantly harmed. Some political and religiousgroups have voiced opposition to our technology and practices. We use stemcells derived from human embryos that have been created for in vitro fertilizationprocedures but are no longer desired or suitable for that use and are donatedwith appropriate informed consent for research use . Many researchinstitutions, including some of our scientific collaborators, have adoptedpolicies regarding the ethical use of human embryonic tissue. These policiesmay have the effect of limiting the scope of research conducted usinghuman embryonic stem cells, thereby impairing our ability to conduct researchin this field.

Potential and actual legislation and regulation at thefederal or state level related to our technology could limit our activities andability to develop products for commercial sales, depriving us of ouranticipated source of future revenues. For example, in July 2001, theHouse of Representatives of the United States Congress passed a bill, HR 2505,the “Human Cloning Prohibition Act of 2001.” This bill was placed on thecalendar of the U.S. Senate in August 2002, where it did not pass.However, similar bills could be introduced in the future aiming to prohibit theuse or commercialization of somatic cell nuclear transfer technology or of anyproducts resulting from it, including those related to human therapeuticcloning and regenerative medicine. Such legislation could have a significantinfluence on our ability to pursue our research, development andcommercialization plans in the United States.

Any future or additional government-imposedrestrictions in these or other jurisdictions with respect to use of embryos orhuman embryonic stem cells in research and development could have a materialadverse effect on us, by, among other things:

·              harmingour ability to establish critical partnerships and collaborations,

·                                          delayingor preventing progress in our research and development,

·                                          limitingor preventing the development, sale or use of our products, and

·                                          causinga decrease in the price of our stock.

**Because we or ourcollaborators must obtain regulatory approval to market our products in theUnited States and other countries, we cannot predict whether or when we will bepermitted to commercialize our products.  **Federal, state and local governments in the UnitedStates and governments in other countries have significant regulations in placethat govern many of our activities. We are or may become subject tovarious federal, state and local laws, regulations and recommendations relatingto safe working conditions, laboratory and manufacturing practices, theexperimental use of animals and the use and disposal of hazardous orpotentially hazardous substances used in connection with our research anddevelopment work. The preclinical testing and clinical trials of the productsthat we or our collaborators develop are subject to extensive governmentregulation that may prevent us from creating commercially viable productsfrom our discoveries. In addition, the sale by us or our collaborators of anycommercially viable product will be subject to government regulation fromseveral standpoints, including manufacturing, advertising and promoting,selling and marketing, labeling, and distributing.

If, and to the extent that, we are unable to complywith these regulations, our ability to earn revenues will be materially andnegatively impacted. The regulatory process, particularly in the biotechnologyfield, is uncertain, can take many years and requires the expenditure ofsubstantial resources. Biological drugs and non-biological drugs are rigorouslyregulated. In particular, proposed human pharmaceutical therapeutic productcandidates are subject to rigorous preclinical and clinical testing and otherrequirements by the FDA in the United States and similar health authorities inother countries in order to demonstrate safety and efficacy. We may neverobtain regulatory approval to market our proposed products. For additionalinformation about governmental regulations that will affect our planned andintended business operations, see the Company’s Annual Report on Form 10-KSBfiled with the SEC on March 31, 2006 under the heading “DESCRIPTION OFBUSINESS—*Government Regulation*”.

Our products may not receive FDA approval, whichwould prevent us from commercially marketing our products and producingrevenues. The FDA and comparable government agencies in foreign countriesimpose substantial regulations on the manufacture and marketing ofpharmaceutical products through lengthy and detailed

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laboratory, pre-clinical and clinical testingprocedures, sampling activities and other costly and time-consuming procedures.Satisfaction of these regulations typically takes several years or more andvaries substantially based upon the type, complexity and novelty of theproposed product. We cannot yet accurately predict when we might first submitany Investigational New Drug, or IND, application to the FDA, or whether anysuch IND application would be granted on a timely basis, if at all, nor can weassure you that we will successfully complete any clinical trials in connectionwith any such IND application. Further, we cannot yet accurately predict whenwe might first submit any product license application for FDA approval orwhether any such product license application would be granted on a timelybasis, if at all. As a result, we cannot assure you that FDA approvals for anyproducts developed by us will be granted on a timely basis, if at all. Any suchdelay in obtaining, or failure to obtain, such approvals could have a materialadverse effect on the marketing of our products and our ability to generateproduct revenue. For additional information about governmental regulations thatwill affect our planned and intended business operations, see Company’s AnnualReport on Form 10-KSB filed with the SEC on March 31, 2006under the heading “DESCRIPTION OF BUSINESS—*GovernmentRegulation*.

**For-profit entitiesmay be prohibited from benefiting from grant funding.  **There has been much publicity about grant resourcesfor stem cell research, including Proposition 71 in California, which isdescribed more fully in the Company’s Annual Report on Form 10-KSBfiled with the SEC on March 31, 2006 under the heading “DESCRIPTION OFBUSINESS —*California Proposition 71*”.There is ongoing litigation in California that may delay, or prevent thesale of State bonds that would fund the activities contemplated by Californiavoters. In addition, rules and regulations related to any funding thatmay ultimately be provided, the type of entity that will be eligible forfunding, the science to be funded, and funding details have not been finalized.As a result of these uncertainties regarding Proposition 71, we cannot assureyou that funding, if any, will be available to us, or any for-profit entity.

**The governmentmaintains certain rights in technology that we develop using government grantmoney and we may lose the revenues from such technology if we do notcommercialize and utilize the technology pursuant to established governmentguidelines.  **Certain ofour and our licensors’ research has been or is being funded in part bygovernment grants. In connection with certain grants, the U.S. governmentretains rights in the technology developed with the grant. These rights couldrestrict our ability to fully capitalize upon the value of this research.

**Risks Relating to Our Reliance on Third Parties**

**We depend on ourcollaborators to help us develop and test our proposed products, and ourability to develop and commercialize products may be impaired or delayedif collaborations are unsuccessful.  **Our strategy for the development, clinical testingand commercialization of our proposed products requires that we enter intocollaborations with corporate partners, licensors, licensees and others. We aredependent upon the subsequent success of these other parties in performingtheir respective responsibilities and the continued cooperation of ourpartners. Our collaborators may not cooperate with us orperform their obligations under our agreements with them. We cannotcontrol the amount and timing of our collaborators’ resources that will bedevoted to our research and development activities related to our collaborativeagreements with them. Our collaborators may choose to pursue existing oralternative technologies in preference to those being developed incollaboration with us.

Under agreements with collaborators, we may relysignificantly on such collaborators to, among other things:

·                                          designand conduct advanced clinical trials in the event that we reach clinicaltrials,

·                                          fundresearch and development activities with us,

·                                          payus fees upon the achievement of milestones, and

·                                          marketwith us any commercial products that result from our collaborations.

The development and commercialization of potentialproducts will be delayed if collaborators fail to conduct these activities in atimely manner or at all. In addition, our collaborators could terminate theiragreements with us and we may not receive any development or milestonepayments. If we do not achieve milestones set forth in the

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agreements, or if our collaborators breach orterminate their collaborative agreements with us, our business may bematerially harmed.

**Our reliance onthe activities of our non-employee consultants, research institutions, andscientific contractors, whose activities are not wholly within our control,may lead to delays in development of our proposed products.  **We rely extensively upon and have relationships withscientific consultants at academic and other institutions, some of whom conductresearch at our request, and other consultants with expertise in clinicaldevelopment strategy or other matters. These consultants are not our employeesand may have commitments to, or consulting or advisory contracts with,other entities that may limit their availability to us. We have limitedcontrol over the activities of these consultants and, except as otherwiserequired by our collaboration and consulting agreements to the extent theyexist, can expect only limited amounts of their time to be dedicated to ouractivities.

In addition, we have formed research collaborationswith academic and other research institutions throughout the world. Theseresearch facilities may have commitments to other commercial andnon-commercial entities. We have limited control over the operations of theselaboratories and can expect only limited amounts of time to be dedicated to ourresearch goals.

We also rely on other companies for certain processdevelopment or other technical scientific work. We have contracts with thesecompanies that specify the work to be done and results to be achieved, but wedo not have direct control over their personnel or operations. If any of thesethird parties are unable or refuse to contribute to projects on which we needtheir help, our ability to generate advances in our technologies and developour products could be significantly harmed.

**General Risks Relating to Our Business**

**We may be subject tolitigation that will be costly to defend or pursue and uncertain in itsoutcome.  **Our businessmay bring us into conflict with our licensees, licensors, or others withwhom we have contractual or other business relationships, or with ourcompetitors or others whose interests differ from ours. If we are unable toresolve those conflicts on terms that are satisfactory to all parties, wemay become involved in litigation brought by or against us. Thatlitigation is likely to be expensive and may require a significant amountof management’s time and attention, at the expense of other aspects of ourbusiness. The outcome of litigation is always uncertain, and in some casescould include judgments against us that require us to pay damages, enjoin usfrom certain activities, or otherwise affect our legal or contractual rights,which could have a significant adverse effect on our business. Additionaldiscussion regarding litigation in which we are involved is set forth inPart II Item I of this Quarterly Report and contained in the Company’sAnnual Report on Form 10-KSB filed with the SEC on March 31,2006.

**We may not beable to obtain third-party patient reimbursement or favorable product pricing,which would reduce our ability to operate profitably.  **Our ability to successfully commercialize certain ofour proposed products in the human therapeutic field may depend to asignificant degree on patient reimbursement of the costs of such products andrelated treatments at acceptable levels from government authorities, privatehealth insurers and other organizations, such as health maintenanceorganizations. We cannot assure you that reimbursement in the United States orforeign countries will be available for any products we may develop or, ifavailable, will not be decreased in the future, or that reimbursement amountswill not reduce the demand for, or the price of, our products with a consequentharm to our business. We cannot predict what additional regulation orlegislation relating to the health care industry or third-party coverage andreimbursement may be enacted in the future or what effect such regulationor legislation may have on our business. If additional regulations areoverly onerous or expensive, or if health care related legislation makes ourbusiness more expensive or burdensome than originally anticipated, wemay be forced to significantly downsize our business plans or completelyabandon our business model.

**Our products arelikely to be expensive to manufacture, and they may not be profitable ifwe are unable to control the costs to manufacture them.  **Our products are likely to be significantly moreexpensive to manufacture than most other drugs currently on the market today.Our present manufacturing processes produce modest quantities of productintended for use in our ongoing research activities, and we have not developedprocesses, procedures and capability to produce commercial volumes of product.We hope to substantially reduce manufacturing costs through processimprovements, development of new science, increases in manufacturing scale andoutsourcing to experienced manufacturers. If we are not able to make these orother improvements, and

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**dependingon the pricing of the product, our profit margins may be significantlyless than that of most drugs on the market today. In addition, we may notbe able to charge a high enough price for any cell therapy product we develop,even if they are safe and effective, to make a profit. If we are unable torealize significant profits from our potential product candidates, our businesswould be materially harmed.**

**To be successful,our proposed products must be accepted by the health care community, which canbe very slow to adopt or unreceptive to new technologies and products.  **Our proposed products and those developed by ourcollaborative partners, if approved for marketing, may not achieve marketacceptance since hospitals, physicians, patients or the medical community ingeneral may decide not to accept and utilize these products. The productsthat we are attempting to develop represent substantial departures fromestablished treatment methods and will compete with a number of moreconventional drugs and therapies manufactured and marketed by majorpharmaceutical companies. The degree of market acceptance of any of ourdeveloped products will depend on a number of factors, including:

·                                          ourestablishment and demonstration to the medical community of the clinicalefficacy and safety of our proposed products;

·                                          ourability to create products that are superior to alternatives currently on themarket;

·                                          ourability to establish in the medical community the potential advantage of ourtreatments over alternative treatment methods; and

·                                          reimbursementpolicies of government and third-party payors.

If the health care community does not accept ourproducts for any of the foregoing reasons, or for any other reason, ourbusiness would be materially harmed.

**Our current source ofrevenues depends on the stability and performance of our sublicensees.  **Our ability to collect royalties on product salesfrom our sublicensees will depend on the financial and operational success ofthe companies operating under a sublicense. We have numerous licensees to thirdparties including Lifeline Cell Technology, Exeter Life Sciences and GTCBiotherapeutics, as well as others that hold licenses to our technology.Revenues from those licensees will depend upon the financial and operationalsuccess of those third parties. We cannot assure you that these licensees willbe successful in obtaining requisite financing or in developing andsuccessfully marketing their products. These licensees may experienceunanticipated obstacles including regulatory hurdles, and scientific ortechnical challenges, which could have the effect of reducing their ability togenerate revenues and pay us royalties.

**We depend on keypersonnel for our continued operations and future success, and a loss ofcertain key personnel could significantly hinder our ability to move forwardwith our business plan.  **Becauseof the specialized nature of our business, we are highly dependent on ourability to identify, hire, train and retain highly qualified scientific andtechnical personnel for the research and development activities we conduct orsponsor. The loss of one or more certain key executive officers, or scientificofficers, would be significantly detrimental to us. In addition, recruiting andretaining qualified scientific personnel to perform research anddevelopment work is critical to our success. Our anticipated growth andexpansion into areas and activities requiring additional expertise, such asclinical testing, regulatory compliance, manufacturing and marketing, willrequire the addition of new management personnel and the development ofadditional expertise by existing management personnel. There is intensecompetition for qualified personnel in the areas of our present and plannedactivities, and there can be no assurance that we will be able to continue toattract and retain the qualified personnel necessary for the development of ourbusiness. The failure to attract and retain such personnel or to develop suchexpertise would adversely affect our business.

**Our credibility asa business operating in the field of human embryonic stem cells is largelydependent upon the support of our Ethics Advisory Board.  **Because the use of human embryonic stem cells givesrise to ethical, legal and social issues, we have instituted an Ethics AdvisoryBoard. Our Ethics Advisory Board is made up of highly qualified individualswith expertise in the field of human embryonic stem cells. We cannot assure youthat these members will continue to serve on our Ethics Advisory Board, and theloss of any such member may affect the

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credibility and effectiveness of the Board. As aresult, our business may be materially harmed in the event of any suchloss.

**Our insurance policiesmay be inadequate and potentially expose us to unrecoverable risks.  **We have limited director and officer insurance andcommercial insurance policies. Any significant insurance claims would have amaterial adverse effect on our business, financial condition and results ofoperations. Insurance availability, coverage terms and pricing continue to varywith market conditions. We endeavor to obtain appropriate insurance coveragefor insurable risks that we identify, however, we may fail to correctlyanticipate or quantify insurable risks, we may not be able to obtainappropriate insurance coverage, and insurers may not respond as we intendto cover insurable events that may occur. We have observed rapidlychanging conditions in the insurance markets relating to nearly all areas oftraditional corporate insurance. Such conditions have resulted in higherpremium costs, higher policy deductibles, and lower coverage limits. For somerisks, we may not have or maintain insurance coverage because of cost oravailability.

**We have no product liabilityinsurance, which may leave us vulnerable to future claims we will beunable to satisfy.  **Thetesting, manufacturing, marketing and sale of human therapeutic products entailan inherent risk of product liability claims, and we cannot assure you thatsubstantial product liability claims will not be asserted against us. We haveno product liability insurance. In the event we are forced to expendsignificant funds on defending product liability actions, and in the eventthose funds come from operating capital, we will be required to reduce ourbusiness activities, which could lead to significant losses.

We cannot assure you that adequate insurance coveragewill be available in the future on acceptable terms, if at all, or that, ifavailable, we will be able to maintain any such insurance at sufficient levelsof coverage or that any such insurance will provide adequate protection againstpotential liabilities. Whether or not a product liability insurance policy isobtained or maintained in the future, any product liability claim could harmour business or financial condition.

**We need to improve our financialcontrol procedures.  **Sincethe January 31, 2005 merger, we have determined that there aredeficiencies in the operating effectiveness of our internal controls overfinancial reporting that we believe would collectively constitute significantdeficiencies and material weaknesses under standards established by theAmerican Institute of Certified Public Accountants, resulting in more than aremote likelihood that a material misstatement of our annual or interimfinancial statements will not be prevented or detected. Since the merger,additional management processes and procedures have been added to supplementthe underlying systems of internal accounting control to allow timelypreparation and filing of required financial reports.

In our opinion, we have not established and did notmaintain effective internal control over financial reporting as of June 30,2006. We also believe that because of the effect of the material weakness wehave identified, we have not maintained effective internal control overfinancial reporting as of June 30, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. We have taken initial remedial steps,and will continue our on-going evaluation of internal controls and expect toimprove our internal controls over financial reporting as necessary to assuretheir effectiveness, but there can be no assurance that we will succeed or thatother deficiencies will not be identified.

**We presently havemembers of management and other key employees located in various locationsthroughout the country which adds complexities to the operation of thebusiness.  **Presently,we have members of management and other key employees located in bothCalifornia and Massachusetts, which adds complexities to the operation of ourbusiness. We intend to maintain our research facilities in Massachusetts and wehave established corporate offices and an additional research facility inCalifornia. We will likely continue to incur significant costs associated withmaintaining multiple locations.

**We face risks related tocompliance with corporate governance laws and financial reporting standards.  **The Sarbanes-Oxley Act of 2002, as well as relatednew rules and regulations implemented by the Securities and ExchangeCommission and the Public Company Accounting Oversight Board, require changesin the corporate governance practices and financial reporting standards forpublic companies. These new laws, rules and regulations, includingcompliance with Section 404 of the Sarbanes-Oxley Act of 2002 relating tointernal control over financial reporting, referred to as Section 404,have materially increased our legal and financial compliance costs and made

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** **

some activities more time-consuming and moreburdensome. In the event we exceed certain minimum market capitalizationvalues, Section 404 requires that our management assess our internalcontrol over financial reporting annually and include a report on itsassessment in our annual report. Our independent registered public accountingfirm may be required to audit both the design and operating effectiveness ofour internal controls and management’s assessment of the design and theoperating effectiveness of our internal controls. There exist materialweaknesses and deficiencies at this time in our internal controls. Theseweaknesses and deficiencies could have a material adverse effect on ourbusiness and operations.

**Risks Relating to Our Common Stock**

**Stock prices forbiotechnology companies have historically tended to be very volatile.  **Stock prices and trading volumes for manybiotechnology companies fluctuate widely for a number of reasons, including butnot limited to the following factors, some of which may be unrelated totheir businesses or results of operations:

·                                          clinicaltrial results

·                                          theamount of cash resources and ability to obtain additional funding

·                                          announcementsof research activities, business developments, technological innovations or newproducts by companies or their competitors

·                                          enteringinto or terminating strategic relationships

·                                          changesin government regulation

·                                          disputesconcerning patents or proprietary rights

·                                          changesin revenues or expense levels

·                                          publicconcern regarding the safety, efficacy or other aspects of the products ormethodologies being developed

·                                          reportsby securities analysts

·                                          activitiesof various interest groups or organizations

·                                          mediacoverage

·                                          statusof the investment markets

This market volatility, as well as general domestic orinternational economic, market and political conditions, could materially andadversely affect the market price of our common stock and the return on yourinvestment.

**A significant numberof shares of our common stock became available for sale in January of 2006and their sale could depress the price of our common stock.  **On January 31, 2006, a significant number ofour outstanding securities that were previously restricted became eligible forsale under Rule 144 of the Securities Act.

Not including the shares of common stock underlyingthe convertible debentures and the warrants issued in connection with theSeptember 2005 financing, as of July 25, 2006, there are presentlyapproximately 26,500,000 outstanding options, warrants and other securitiesconvertible or exercisable into shares of our common stock.

We may also sell a substantial number ofadditional shares of our common stock in connection with a private placement orpublic offering of shares of our common stock (or other series orclass of capital stock to be designated in the future). The terms of anysuch private placement would likely require us to register the resale of anyshares of capital stock issued or issuable in the transaction. We have alsoissued common stock to certain parties, such as vendors and service providers,as payment for products and services. Under these arrangements, wemay agree to register the shares for resale soon after their issuance. Wemay also continue to pay for certain goods and services with equity, whichwould dilute your interest in the company.

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Sales of a substantial number of shares of our commonstock under any of the circumstances described above could adversely affect themarket price for our common stock and make it more difficult for you to sellshares of our common stock at times and prices that you feel are appropriate.

**We do not intend to pay cashdividends on our common stock in the foreseeable future.  **Any payment of cash dividends will depend upon ourfinancial condition, results of operations, capital requirements and otherfactors and will be at the discretion of our board of directors. We do notanticipate paying cash dividends on our common stock in the foreseeable future.Furthermore, we may incur additional indebtedness that may severelyrestrict or prohibit the payment of dividends.

**Our securities arequoted on the OTC Bulletin Board, which may limit the liquidity and priceof our securities more than if our securities were quoted or listed on theNasdaq Stock Market or a national exchange.  **Our securities are currently quoted on the OTCBulletin Board, an NASD-sponsored and operated inter-dealer automated quotationsystem for equity securities not included in the Nasdaq Stock Market. Quotationof our securities on the OTC Bulletin Board may limit the liquidity andprice of our securities more than if our securities were quoted or listed onThe Nasdaq Stock Market or a national exchange. Some investorsmay perceive our securities to be less attractive because they are tradedin the over-the-counter market. In addition, as an OTC Bulletin Board listedcompany, we do not attract the extensive analyst coverage that accompaniescompanies listed on Nasdaq or any other regional or national exchange. Further,institutional and other investors may have investment guidelines thatrestrict or prohibit investing in securities traded in the over-the-countermarket. These factors may have an adverse impact on the trading and priceof our securities.

**Our common stock is subjectto “penny stock” regulations and restrictions on initial and secondarybroker-dealer sales.  **TheSecurities and Exchange Commission has adopted regulations which generallydefine “penny stock” to be any listed, trading equity security that has amarket price less than $5.00 per share or an exercise price of less than $5.00per share, subject to certain exemptions. Penny stocks are subject to certainadditional oversight and regulatory requirements. Brokers and dealers affectingtransactions in our common stock in many circumstances must obtain the writtenconsent of a customer prior to purchasing our common stock, must obtaininformation from the customer and must provide disclosures to the customer.These requirements may restrict the ability of broker-dealers to sell ourcommon stock and may affect your ability to sell your shares of our commonstock in the secondary market.

**ITEM 3.   CONTROLSAND PROCEDURES**

(a)    *Evaluation of disclosure controls and procedures.*Ourmanagement, with the participation of our principal executive officer, has evaluatedthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of theperiod covered by this Quarterly Report on Form 10-QSB. Based onsuch evaluation, due to the material weaknesses in our internal controls overfinancial reporting further described below, our principal executive officerhas concluded that such disclosure controls and procedures were not effectivein providing reasonable assurance that information required to be disclosed byus in the reports we file or submitted by us under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms. We have implemented, and are in the processof implementing, new disclosure controls and procedures to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported with thetime periods specified in applicable SEC rules and forms are effective.

(b)    *Changes in internal controls.*Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting. Our internal control system is intended toprovide reasonable assurance to our management and board of directors regardingthe preparation and fair presentation of published financial statements. Ourmanagement assessed the effectiveness of our internal control over financialreporting as of June 30, 2006. In making its assessment of internal controlover financial reporting, management used the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control — Integrated Framework.

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Management’s assessment identified materialdeficiencies in our internal control over financial reporting. Thesedeficiencies include lack of segregation of duties, limited capability tointerpret and apply United States generally accepted accounting principles,lack of adequate documentation of our system of internal controls, lack offormal accounting policy and procedures and related documentation, deficienciesin our information technology systems and lack of a formal budgeting process. Wealso have not yet instituted new internal control processes related to ouridentified material weaknesses, significant deficiencies and deficiencies, ashas been characteristic of companies that have completed their review ofinternal controls and have had to report on the effect of such review.Accordingly, our internal control over financial reporting may be subjectto additional material weaknesses and deficiencies that we have not identified.Management has determined that these significant deficiencies, in theaggregate, constituted a material weakness in the design and operation of ourinternal controls in effect prior to June 30, 2006. We hired a chief financialofficer on April 1, 2005, and we are in the process of implementing newcontrols; however, these controls were not fully in operation during the secondquarter of 2006. As a result of the material weaknesses described in thepreceding paragraph, we believe that, as of June 30, 2006, our internal controlover financial reporting was not effective based on the COSO criteria.

**PART II.OTHER INFORMATION**

**ITEM1.   LEGAL PROCEEDINGS**

*University ofMassachusetts and Advanced Cell Technology, Inc. v. Roslin Institute(Edinburgh), Geron Corporation and Exeter Life Sciences, Inc., U.S.District Court for the District of Columbia*. We filed an action on February 18, 2005 in theU.S. District Court for the District of Columbia. We brought this action under35 U.S.C. 146 to reverse the decision of the Board of Patent Appeals andInterferences regarding a patent to a method of cloning non-human animals. Thepatent, U.S. Patent No. 5,945,577, is licensed by Umass exclusively to us.The parties are actively engaged in settlement discussions. Adversedeterminations in this proceeding would likely have a materially adverse effecton our business.

*University ofMassachusetts and Advanced Cell Technology, Inc. v. Roslin Institute(Edinburgh), Geron Corporation and Exeter Life Sciences, Inc., U.S.District Court for the District of Columbia.*We filed an action on April 7, 2005 in the U.S.District Court for the District of Columbia. We brought this action under 35U.S.C. 146 to reverse the decision of the Board of Patent Appeals andInterferences regarding a patent to a method of creating embryonic stem cells.The patent, U.S. Patent No. 6,235,970, is licensed by Umass exclusively tous. The parties are actively engaged in settlement discussions. Adversedeterminations in this proceeding would likely have a materially adverse effecton our business.

*University ofMassachusetts v. James M. Robl and Philippe Collas, Massachusetts SuperiorCourt (Suffolk County).*UMassfiled a complaint on February 22, 2004 in the Superior Court (SuffolkCounty) for the Commonwealth of Massachusetts. Adecision adverse to UMass in this litigation could have had a materiallyadverse effect on our business. The complaint alleged the misappropriation bythe defendants of valuable inventions in the fields of animal cloning and cellreprogramming, made by the defendants at UMass and with UMass support, that areexclusively licensed to us by UMass. The complaint included counts fordeclaratory judgment, breach of contract seeking specific performance,injunctive relief and damages, intentional interference with contract andprospective contractual relations, conversion, breach of duty, and breach ofthe covenant of good faith and fair dealing. The Company successfullyintervened in the litigation to protect its interests. In May 2006, theparties to the litigation reached a settlement agreement and the case has beendismissed.

**ITEM2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

The issuances of the equity securities described belowwere made in reliance upon the exemption from registration underSection 4(2) of the Securities Act of 1933, as amended, relating tosales by an issuer not involving a public offering, and/or pursuant to therequirements of one or more of the safe harbors provided in Regulation Dunder the Securities Act or, in the case of equity compensation to employees,directors and eligible consultants, Rule 701 therewith.

On April 21, 2006, we issued a warrant to purchase20,000 shares of common stock at an exercise price of $2.54 per share to ChadGriffin in connection with consulting services provided to us by Mr. Griffin.

On April 24, 2006, we issued a warrant to purchase300,000 shares of common stock at an exercise price of $2.54 per share toStephen Price in connection with consulting services provided to us by Mr.Price.

**ITEM3.   DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

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**ITEM5.   OTHER INFORMATION**

None.

**ITEM6.   EXHIBITS AND REPORTS ON FORM 8-K**

(a)           Exhibits.
|                      | ** ** | ** **                                                                                                                                                                   |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Exhibit No.** | ** ** | **Exhibit  Description**                                                                                                                                                     |
| ** **           | ** ** | ** **                                                                                                                                                                   |
| 10.1                 |       | Non-Exclusive License Agreement between Kirin Beer  Kabushiki Kaisha, Aurox, LLC, Hematech, LLC, and Kirin SD, Inc., and  Advanced Cell Technology, Inc., dated May 9, 2006* |
|                 |       |                                                                                                                                                                         |
| 10.2                 |       | Exclusive License Agreement between Kirin Beer  Kabushiki Kaisha, Aurox, LLC, Hematech, LLC, and Kirin SD, Inc., and  Advanced Cell Technology, Inc., dated May 9, 2006**    |
|                 |       |                                                                                                                                                                         |
| 10.3                 |       | Purchase Agreement between Kirin SD, Inc. and  Advanced Cell Technology, Inc. dated May 9, 2006**                                                                            |
|                 |       |                                                                                                                                                                         |
| 31.1                 |       | Section 302  Certification of Chief Executive Officer*                                                                                                                  |
|                 |       |                                                                                                                                                                         |
| 31.2                 |       | Section 302  Certification of Chief Financial Officer*                                                                                                                  |
|                 |       |                                                                                                                                                                         |
| 32.1                 |       | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350*                                                                                           |
|                 |       |                                                                                                                                                                         |
| 32.2                 |       | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350*                                                                                           |

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*                    Filedherewith

**             Filedherewith. Confidential treatment has been requested with respect to the omittedportions of this exhibit. This copy omits information subject to aconfidentiality request filed with the Securities and Exchange Commission.Omissions are designated with the characters [***]. A complete version of thisexhibit has been filed separately with the Securities and Exchange Commissionalong with the request for confidential treatment.

(b)           Reportson Form 8-K

On May 15, 2006, the Company filed a Current Report onForm 8-K announcing that it had entered into certain licensingagreements with Kirin Beer Kabushiki Kaisha and certain of its subsidiaries.

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**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned hereuntoduly authorized.
|                        | ** ** | **ADVANCED CELL TECHNOLOGY, INC.** |
|------------------------|------------|------------------------------------|
| ** **             | ** ** | ** **                         |
|                   |       | By:                                |  /s/ William  M. Caldwell, IV |   |
|                   |       |                               | William M. Caldwell, IV |
|                   |       |                               | Chief Executive Officer |
| Dated: August 11, 2006 |       |                               |

 

 

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**Exhibit Index**

** **
| Exhibit No. | ** ** | **Exhibit Description**                                                                                                                                                  | ** ** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** **                                                                                                                                                                    | ** ** |
| 10.1             |       | Non-Exclusive License  Agreement between Kirin Beer Kabushiki Kaisha, Aurox, LLC, Hematech,  LLC, and Kirin SD, Inc., and Advanced Cell Technology, Inc., dated May  9, 2006* |       |
|             |       |                                                                                                                                                                          |       |
| 10.2             |       | Exclusive License  Agreement between Kirin Beer Kabushiki Kaisha, Aurox, LLC, Hematech,  LLC, and Kirin SD, Inc., and Advanced Cell Technology, Inc., dated May  9, 2006**    |       |
|             |       |                                                                                                                                                                          |       |
| 10.3             |       | Purchase Agreement  between Kirin SD, Inc. and Advanced Cell Technology, Inc. dated May 9, 2006**                                                                             |       |
|             |       |                                                                                                                                                                          |       |
| 31.1             |       | Section 302 Certification of Chief Executive  Officer*                                                                                                                   |       |
|             |       |                                                                                                                                                                          |       |
| 31.2             |       | Section 302 Certification of Chief Financial  Officer*                                                                                                                   |       |
|             |       |                                                                                                                                                                          |       |
| 32.1             |       | Certification of Chief Executive Officer pursuant to 18  U.S.C. Section 1350*                                                                                            |       |
|             |       |                                                                                                                                                                          |       |
| 32.2             |       | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350*                                                                                            |       |

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*                    Filedherewith

**             Filedherewith. Confidential treatment has been requested with respect to the omittedportions of this exhibit. This copy omits information subject to aconfidentiality request filed with the Securities and Exchange Commission.Omissions are designated with the characters [***]. A complete version of thisexhibit has been filed separately with the Securities and Exchange Commissionalong with the request for confidential treatment.

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