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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

OR

o         TRANSITION REPORT UNDER SECTION 13 OF 15(d) OR THE EXCHANGE ACT OF 1934

From the transition period from            to             .

Commission File Number 001-36067

FATE THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (858) 875-1800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes o  No x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of November 11, 2013, there were 20,357,158 shares of the registrant’s common stock, par value $0.001 per share, outstanding.

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FATE THERAPEUTICS, INC.

FORM 10-Q

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PART I. FINANCIAL INFORMATION

Item 1.   Financial Statements

Fate Therapeutics, Inc.

(A Development Stage Company)

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

See accompanying notes.

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Fate Therapeutics, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except share and per share data)

See accompanying notes.

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Fate Therapeutics, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes.

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Fate Therapeutics, Inc.

(A Development Stage Company)

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.                       Organization and Summary of Significant Accounting Policies

Organization

Fate Therapeutics, Inc. (the “Company”) was incorporated in the state of Delaware on April 27, 2007 and conducts its principal operations in San Diego, California. The Company is a clinical-stage biopharmaceutical company engaged in the discovery and development of pharmacologic modulators of adult stem cells. Based on the Company’s understanding of key biological mechanisms that guide the fate of adult stem cells, the Company has built two platforms that optimize the activity and enhance the therapeutic potential of adult stem cells: its hematopoietic stem cell, or HSC, modulation platform and its muscle satellite stem cell, or SSC, modulation platform.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries, Fate Therapeutics (Canada) Inc. (“Fate Canada”), Fate Therapeutics Ltd., incorporated in the United Kingdom, and Destin Therapeutics Inc., incorporated in Canada. To date, the aggregate operations of these subsidiaries have not been significant and all intercompany transactions and balances have been eliminated in consolidation.

Reverse Stock Split

On September 12, 2013, the Company filed an amendment to its amended and restated certificate of incorporation, effecting a one-for-6.5 reverse stock split of the Company’s issued and outstanding shares of common stock. All issued and outstanding common stock and per share amounts contained in the Company’s consolidated financial statements have been retroactively adjusted to reflect this reverse stock split for all periods presented.

Unaudited Interim Financial Information

The accompanying interim condensed consolidated financial statements are unaudited. These unaudited interim financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) and following the requirements of the United States Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted.  In management’s opinion, the unaudited interim financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the Company’s financial position and its results of operations and comprehensive loss and its cash flows for periods presented. These statements do not include all disclosures required by GAAP and should be read in conjunction with the Company’s financial statements and accompanying notes for the fiscal year ended December 31, 2012, contained in the Company’s final prospectus dated September 30, 2013 filed by the Company with the SEC on October 1, 2013 pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”), in connection with the Company’s initial public offering (“IPO”). The results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results expected for the full fiscal year or any other interim period or any future year or period.

Use of Estimates

The Company’s consolidated financial statements are prepared in accordance with GAAP. The preparation of the Company’s consolidated financial statements requires it to make estimates and assumptions that impact the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in the Company’s consolidated financial statements and accompanying notes. The most significant estimates in the Company’s consolidated financial statements relate to the valuation of equity awards and clinical trial accruals. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may ultimately materially differ from these estimates and assumptions.

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Other Assets

Other assets consist of the Company’s deferred IPO costs. These costs represent legal, accounting and other direct costs related to the Company’s efforts to raise capital through a public sale of its common stock. Future costs will be deferred until the completion of the IPO, at which time they will be reclassified to additional paid-in capital as a reduction of the IPO proceeds.

Preferred Stock Warrant Liability

The Company has issued freestanding warrants to purchase shares of its convertible preferred stock. The fair value of these warrants is classified as a current liability in the accompanying consolidated balance sheets since the underlying convertible preferred stock has been classified as temporary equity in the accompanying consolidated balance sheets instead of in stockholders’ deficit in accordance with authoritative guidance for the classification and measurement of potentially redeemable securities. Upon certain change in control events that are outside of the Company’s control, including liquidation, sale or transfer of control of the Company, holders of the convertible preferred stock can cause its redemption. The warrants are recorded at fair value using the Black-Scholes option pricing model with any changes in fair value being recognized as a component of other income (expense) in the accompanying consolidated statements of operations and comprehensive loss. The warrant liability will continue to be remeasured at fair value until such time as the warrants are no longer outstanding or the underlying securities are no longer redeemable outside the control of the Company.

Revenue Recognition

The Company recognizes revenues when all four of the following criteria are met: (i) persuasive evidence that an agreement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured.

Revenue arrangements with multiple elements are analyzed to determine whether the elements can be divided into separate units of accounting or whether the elements must be accounted for as a single unit of accounting. The Company divides the elements into separate units of accounting and applies the applicable revenue recognition criteria to each of the elements, if the delivered elements have value to the customer on a stand-alone basis, if the arrangement includes a general right of return relative to the delivered elements, and if the delivery or performance of the undelivered elements is considered probable and substantially within the Company’s control.

For transactions entered into prior to 2011, revenue was allocated to each element based on its relative fair value when objective and reliable evidence of fair value existed for all elements in an arrangement. If an element was sold on a stand-alone basis, the fair value of the element was the price charged for the element. When the Company was unable to establish fair value for delivered elements or when fair value of undelivered elements had not been established, revenue was deferred until all elements were delivered or until fair value could be objectively determined for any undelivered elements.

Beginning in 2011, revenue is allocated to each element at the inception of the arrangement using the relative selling price method that is based on a three-tier hierarchy. The relative selling price method requires that the estimated selling price for each element be based on vendor-specific objective evidence (“VSOE”) of fair value, which represents the price charged for each element when it is sold separately or, for an element not yet being sold separately, the price established by management. When VSOE of fair value is not available, third-party evidence (“TPE”) of fair value is acceptable, or a best estimate of selling price is used if neither VSOE nor TPE is available. A best estimate of selling price should be consistent with the objective of determining the price at which the Company would transact if the element were sold regularly on a stand-alone basis and should also take into account market conditions and company-specific factors. The Company has not entered into or materially modified any multiple element arrangements subsequent to 2010.

Revenue arrangements with multiple elements may include license fees, research and development payments, milestone payments, other contingent payments, and royalties on any product sales derived from collaborations. The Company recognizes nonrefundable license fees with stand-alone value as revenue at the time that the Company has satisfied all performance obligations, and recognizes license fees without stand-alone value as revenue in combination with any undelivered performance obligations. The Company recognizes a research and development payment as revenue over the term of the collaboration agreement as contracted amounts are earned, or reimbursable costs are incurred, under the agreement, where contracted amounts are considered to be earned in relative proportion to the performance required under the applicable agreement. The Company recognizes a milestone payment, which is contingent upon the achievement of a milestone in its entirety, as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. These criteria include the following: (i) the consideration being earned should be commensurate with either the Company’s performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from the

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Company’s performance to achieve the milestone; (ii) the consideration being earned should relate solely to past performance; (iii) the consideration being earned should be reasonable relative to all deliverables and payment terms in the arrangement; and (iv) the milestone should be considered in its entirety and cannot be bifurcated into substantive and nonsubstantive components. Any amounts received pursuant to revenue arrangements with multiple elements prior to satisfying the Company’s revenue recognition criteria are recorded as deferred revenue on the Company’s consolidated balance sheets.

Revenue from government grants is recorded when reimbursable expenses are incurred under the grant in accordance with the terms of the grant award. The receivable for reimbursable amounts that have not been collected is reflected in prepaid and other current assets.

Stock-Based Compensation

Stock-based compensation expense represents the cost of the grant date fair value of employee stock option grants recognized over the requisite service period of the awards (usually the vesting period) on a straight-line basis, net of estimated forfeitures. For stock option grants for which vesting is subject to performance-based milestones, the expense is recorded over the remaining service period after the point when the achievement of the milestone is probable or the performance condition has been achieved. For stock option grants for which vesting is subject to both performance-based milestones and market conditions, expense is recorded over the derived service period after the point when the achievement of the performance-based milestone is probable or the performance condition has been achieved. The Company estimates the fair value of stock option grants using the Black-Scholes option pricing model, with the exception of option grants for which vesting is subject to both performance-based milestones and market conditions, which are valued using a lattice based model.

The Company accounts for stock options and restricted stock awards to non-employees using the fair value approach. Stock options and restricted stock awards to non-employees are subject to periodic revaluation over their vesting terms. For stock option grants for which vesting is subject to performance-based milestones, the expense is recorded over the remaining service period after the point when the performance condition has been achieved.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding for the period, without consideration for common stock equivalents. Excluded from the weighted-average number of shares outstanding are shares which have been issued upon the early exercise of stock options and are subject to future vesting and unvested restricted stock totaling 102,998 shares and 166,252 shares for the three months ended September 30, 2013 and 2012, respectively, and 111,614 shares and 184,517 shares for the nine months ended September 30, 2013 and 2012, respectively. Diluted net loss per share is calculated by dividing the net loss by the weighted-average number of common stock equivalents outstanding for the period determined using the treasury-stock method. Dilutive common stock equivalents are comprised of convertible preferred stock, warrants for the purchase of convertible preferred stock, exchangeable shares and common stock options outstanding under the Company’s stock option plan. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.

Potentially dilutive securities not included in the calculation of diluted net loss per share because to do so would be anti-dilutive are as follows (in common stock equivalent shares):

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In addition to the potentially dilutive securities noted above, the Company has an aggregate of approximately $23.7 million of outstanding principal as of September 30, 2013 under convertible promissory notes, issued in June 2013, July 2013 and August 2013, that are convertible into convertible preferred stock or common stock upon the occurrence of various future events at prices that are not determinable until the occurrence of those future events. As such, the Company has excluded these convertible notes payable from the table above.  A portion of the convertible notes were repaid in cash and the balance of the notes converted into common stock in connection with the closing of the Company’s IPO in October 2013 (see Note 6).

2.                    Asset Acquisition of Verio Therapeutics Inc.

On April 7, 2010, the Company acquired Verio Therapeutics Inc. (“Verio”), a development stage company headquartered in Ottawa, Ontario to gain access to its exclusively licensed intellectual property.

In connection with the asset acquisition of Verio, the stockholders of Verio received 900,000 non-voting shares of Fate Canada (the “Exchangeable Shares”) that were initially exchangeable into 138,462 shares of our common stock and, subject to the validation of certain scientific data and the achievement of certain preclinical, clinical, commercial and financial milestones, may be exchangeable for up to 884,605 shares of our common stock.

The Exchangeable Shares will be automatically redeemed and exchanged for shares of the Company’s common stock upon the earliest of: (i) April 13, 2017, (ii) the date immediately prior to an IPO of the Company’s common stock pursuant to a registration statement filed with and declared effective by the SEC, (iii) the effective date of certain change of control events, (iv) the date upon which holders of at least a majority of the then outstanding Exchangeable Shares approve the redemption and exchange of all of the outstanding Exchangeable Shares, (v) the date upon which there are less than 450,000 Exchangeable Shares outstanding or (vi) the date that the holders of the Exchangeable Shares can exchange for shares of the Company’s common stock on a tax-deferred basis.

As of September 30, 2013 and December 31, 2012, the Exchangeable Shares were exchangeable into 480,763 shares and 403,841 shares, respectively, of the Company’s common stock. As of September 30, 2013, the number of shares of the Company’s common stock to be issued upon exchange of the Exchangeable Shares is subject to further increase as follows: (i) 76,922 shares for the achievement of certain pre-clinical milestones, (ii) 211,539 shares for the achievement of certain clinical milestones and (iii) 115,381 shares for the achievement of certain commercialization milestones.

At the date of an increase in the number of shares of the Company’s common stock issuable upon any exchange of the Exchangeable Shares due to the achievement of a milestone as described above, the fair value of these additional shares of common stock is charged to research and development expense. At the end of each reporting period, any changes in the fair value of Exchangeable Shares resulting from changes in the fair value of the underlying common stock of the Company are recorded as a component of other income (expense).

As of September 30, 2013, the changes in the number of shares of the Company’s common stock issuable upon the exchange of the Exchangeable Shares and the initial fair value of the shares are summarized as follows (in thousands, except share and per share amounts):

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3.                       Fair Value Measurements

The carrying amounts of accounts payable and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments. Based on the borrowing rates currently available to the Company for loans with similar terms, which is considered a Level 2 input as described below, the Company believes that the fair value of long-term debt approximates its carrying value.

The accounting guidance defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1: Observable inputs such as quoted prices in active markets;

Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Financial assets measured at fair value on a recurring basis consist of the Company’s cash equivalents. As of September 30, 2013 and December 31, 2012, the carrying amount of cash equivalents was $0.3 million and $1.3 million, respectively, which approximates fair value and was determined based upon Level 1 inputs. Cash equivalents primarily consisted of money market funds. As of September 30, 2013 and December 31, 2012, the Company did not hold any Level 2 or Level 3 financial assets that are recorded at fair value on a recurring basis.

Financial liabilities that are measured at fair value on a recurring basis include the preferred stock warrant liability and exchangeable shares (see Note 2). None of the Company’s non-financial assets or liabilities are recorded at fair value on a non-recurring basis. No transfers between levels have occurred during the periods presented.

Liabilities measured at fair value on a recurring basis are as follows (in thousands):

The preferred stock warrant liability was recorded at fair value using the Black-Scholes option pricing model and the exchangeable share liability was recorded at fair value based on the fair value of the underlying common stock.

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The following assumptions were used in the Black-Scholes option pricing model to determine the fair value of the preferred stock warrant liability:

The following table provides a reconciliation of all liabilities measured at fair value using Level 3 significant unobservable inputs (in thousands):

The preferred stock warrant liability and the exchangeable share liability were each reclassified into additional paid-in capital at their fair value in connection with the Company’s IPO on October 4, 2013 (see Note 6).

4.                    Long-Term Debt, Commitments and Contingencies

Long-Term Debt

Long-term debt and unamortized discount balances (excluding convertible debt) are as follows (in thousands):

June and July 2013 Convertible Note Financing

In June and July 2013, the Company issued convertible promissory notes in an aggregate principal amount of $3.7 million to certain existing stockholders. The notes accrue interest at 2% per year and are due on June 24, 2014, if not earlier repaid or converted in full. In connection with the issuance of the convertible notes, the Company recorded a debt discount of $0.3 million related to a beneficial conversion feature that was recorded as a result of the

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gross fair value of the shares of Series C convertible preferred stock into which the debt could convert being greater than the proceeds allocated to the debt instrument. The debt discount is amortized as interest expense utilizing the effective interest method over the one year term of the debt. During the three and nine months ended September 30, 2013, the Company recorded debt discount amortization of $0.1 million. As of September 30, 2013, an aggregate of $3.7 million of principal, $0.3 million of unamortized debt discount and $0.1 million of accrued interest were outstanding under the promissory notes. The notes converted into common stock in connection with the Company’s IPO in October 2013 (see Note 6).

August 2013 Convertible Note Financing

In August 2013, the Company issued convertible promissory notes in an aggregate principal amount of $20.0 million to certain new investors. The notes accrue interest at 2% per year and are due on August 8, 2016, if not earlier repaid or converted in full. As of September 30, 2013, an aggregate of $20.0 million of principal and $0.1 million of accrued interest were outstanding under the promissory notes. A portion of the notes were repaid in cash and the balance of the notes converted into common stock in connection with the Company’s IPO in October 2013 (see Note 6).

Facility Lease

On September 26, 2013, the Company exercised its option to extend for two years the lease on its office and laboratory space in San Diego, California until June 2016. As a result of the lease extension, the Company added an additional $0.5 million, $0.9 million and $0.5 million, respectively, of non-cancelable operating lease commitments for the years ending December 31, 2014, 2015 and 2016.

5.                    Stockholders’ Deficit

2007 Equity Incentive Plan

On August 12, 2013, the Company’s board of directors approved an increase in the number of shares of common stock authorized for issuance under the Company’s 2007 Equity Incentive Plan (the “Plan”) to 2,423,072 shares.

Stock option activity under the Plan is summarized as follows:

The allocation of stock-based compensation for all options and restricted stock awards is as follows (in thousands):

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As of September 30, 2013, the outstanding options included 340,121 performance-based options for which the achievement of the performance-based vesting provisions was determined not to be probable. The aggregate grant date fair value of these unvested options at September 30, 2013 was $1.8 million.

As of September 30, 2013, the outstanding options included 220,496 options with both performance-based milestones and market conditions that were determined not to be probable of achievement. The aggregate grant date fair value of these unvested options at September 30, 2013 was $0.2 million.

As of September 30, 2013, the unrecognized compensation cost related to outstanding options (excluding those with performance-based and/or market conditions) was $0.6 million and is expected to be recognized as expense over approximately 3.5 years.

The weighted-average assumptions used in the Black-Scholes option pricing model to determine the fair value of the employee stock option grants were as follows:

The weighted-average assumptions used in the Black-Scholes option pricing model to determine the fair value of the non-employee stock option grants were as follows:

2013 Stock Option and Incentive Plan

On August 28, 2013, the Company’s board of directors and stockholders approved and adopted the 2013 Stock Option and Incentive Plan (the “2013 Plan”). The 2013 Plan became effective immediately prior to the Company’s IPO. Under the 2013 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units and other awards to individuals who are then employees, officers, directors or consultants of the Company or its subsidiaries. A total of 1,020,000 shares of common stock were initially reserved for issuance under the 2013 Plan. In addition, the number of shares of stock available for issuance under the 2013 Plan will be automatically increased each January 1, beginning on January 1, 2014, by 4% of the outstanding number of shares of the Company’s common stock on the immediately preceding December 31 or such lesser number as determined by the compensation committee of the Company’s board of directors.

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Employee Stock Purchase Plan

On September 13, 2013, the Company’s board of directors approved and adopted the 2013 Employee Stock Purchase Plan (the “ESPP”). The ESPP became effective immediately prior to the Company’s IPO. A total of 729,000 shares of common stock were initially reserved for issuance under the ESPP. In addition, the number of shares of stock available for issuance under the ESPP will be automatically increased each January 1, beginning on January 1, 2015, by the lesser of (i) 2% of the outstanding number of shares of the Company’s common stock on the immediately preceding December 31, (ii) 450,000 shares, or (iii) such lesser number as determined by the compensation committee of the Company’s board of directors.

6.                    Subsequent Events

Initial Public Offering and Related Transactions

On October 4, 2013, the Company completed its IPO whereby it sold 7,666,667 shares of common stock at a public offering price of $6.00 per share. Estimated net proceeds from the IPO were determined as follows (in thousands):

In addition, each of the following occurred in connection with the completion of our IPO on October 4, 2013:

·                  the conversion of all outstanding shares of convertible preferred stock into 7,229,590 shares of the Company’s common stock;

·                  the conversion of $22.1 million of outstanding principal and accrued interest on convertible notes into 3,679,401 shares of common stock, the write-off of $0.3 million of unamortized debt discount and the related cash repayment of $1.7 million of outstanding principal and accrued interest on convertible notes and accrued interest outstanding as of September 30, 2013;

·                  480,763 shares of the Company’s common stock became issuable pursuant to the redemption of an aggregate of 900,000 exchangeable shares of Fate Canada and the resultant reclassification of the exchangeable share liability to additional paid-in capital;

·                  the conversion of warrants to purchase 230,000 shares of convertible preferred stock into warrants to purchase 36,074 shares of the Company’s common stock and the resultant reclassification of the warrant liability to additional paid-in capital; and

·                  an amended and restated certificate of incorporation was filed on October 3, 2013, authorizing 150,000,000 shares of common stock and 5,000,000 shares of undesignated preferred stock.

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The following table summarizes certain actual balance sheet data and pro forma balance sheet data to reflect the activities related to the Company’s IPO noted above, as of September 30, 2013 (in thousands):

In connection with the closing of its IPO on October 4, 2013, the Company recorded an additional aggregate non-cash charge of $0.5 million in other income (expense) related to the final fair value adjustment of the exchangeable share liability and the preferred stock warrant liability. This final fair value adjustment is excluded from the table above.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in this Quarterly Report on Form 10-Q and the financial statements and accompanying notes thereto for the fiscal year ended December 31, 2012 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are contained in our final prospectus dated September 30, 2013, filed with the Securities and Exchange Commission on October 1, 2013 pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”), in connection with our initial public offering.

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward looking statements, which represent our intent, belief, or current expectations, involve risks and uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. In some cases you can identify forward-looking statements by terms such as “may,” “will,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “predict,” “potential,” “believe,” “should” and similar expressions. Factors that could cause or contribute to differences in results include, but are not limited to, those set forth under “Risk Factors” under Item 1A of Part II below, and elsewhere in this Quarterly Report on Form 10-Q. Except as required by law we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes.

Overview

We are a clinical-stage biopharmaceutical company engaged in the discovery and development of pharmacologic modulators of adult stem cells to treat orphan diseases, including certain hematologic malignancies, lysosomal storage disorders and muscular dystrophies. Our novel approaches utilize established pharmacologic modalities, including small molecules and therapeutic proteins, and target well-characterized biological mechanisms to enhance the therapeutic potential of adult stem cells. Based on our deep understanding of key biological mechanisms that guide the fate of adult stem cells, we have built two platforms that optimize the activity of adult stem cells using both ex vivo and in vivo techniques: our hematopoietic stem cell, or HSC, modulation platform and muscle satellite stem cell, or SSC, modulation platform. We believe that the product candidates generated by our platforms have significant potential as life-changing or curative therapeutics across a broad range of orphan indications.

Our HSC modulation platform focuses on the ex vivo pharmacologic optimization of hematopoietic stem cells, or HSCs. Our lead product candidate from this platform, ProHema, is a pharmacologically modulated HSC therapeutic derived from umbilical cord blood. We have established human proof-of-concept for ProHema in a Phase 1b clinical trial by demonstrating enhanced engraftment. We are presently advancing ProHema in Phase 2 clinical development for hematologic malignancies. Our SSC modulation platform focuses on the in vivo pharmacologic activation of satellite stem cells, or SSCs. We have identified Wnt7a as a natural promoter of SSCs to drive muscle regeneration, and we have demonstrated proof-of-concept of Wnt7a analogs as potential therapeutics for muscular dystrophy in preclinical animal studies. We are presently advancing our Wnt7a analogs in preclinical development with the goal of filing an Investigational New Drug application, or IND, in 2014.

Since our inception in 2007, we have devoted substantially all of our resources to the development of our stem cell modulation platforms, the clinical and preclinical advancement of our product candidates, the creation, licensing and protection of related intellectual property and the provision of general and administrative support for these operations. We have generated revenues from collaboration activities and grants, but have not generated any revenues from therapeutic product sales. We have funded our operations primarily through the private placement of preferred stock and convertible notes, through commercial bank debt and through the public offering of common stock. We continue to be classified as a development stage company for financial reporting purposes.

We have never been profitable and have incurred net losses in each year since inception. Substantially all of our net losses resulted from costs incurred in connection with our research and development programs and from general and administrative costs associated with our operations. We expect to continue to incur significant expenses and increasing operating losses for at least the next several years. Our net losses may fluctuate significantly from quarter to quarter and year to year. We expect our expenses will increase substantially in connection with our ongoing activities as we:

·                  conduct clinical trials of our initial product candidates;

·                  continue our research and development efforts;

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·                  manufacture preclinical study and clinical trial materials;

·                  maintain, expand and protect our intellectual property portfolio;

·                  seek regulatory approvals for our product candidates that successfully complete clinical trials;

·                  hire additional clinical, quality control and technical personnel to conduct our clinical trials;

·                  hire additional scientific personnel to support our product development efforts;

·                  implement operational, financial and management systems; and

·                  add general and administrative personnel to operate as a public company.

We do not expect to generate any revenues from therapeutic product sales until we successfully complete development and obtain regulatory approval for one or more of our product candidates, which we expect will take a number of years. If we obtain regulatory approval for any of our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. Accordingly, we will seek to fund our operations through public or private equity or debt financings or other sources. However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all. Our failure to raise capital or enter into such other arrangements when needed would have a negative impact on our financial condition and ability to develop our product candidates.

Recent Developments

On October 4, 2013, we completed our initial public offering (“IPO”) whereby we sold 7,666,667 shares of common stock at a public offering price of $6.00 per share. Estimated net proceeds from our IPO were determined as follows (in thousands):

In addition, each of the following occurred in the fourth quarter of 2013 in connection with the completion of our IPO on October 4, 2013:

·                  the conversion of all outstanding shares of convertible preferred stock into 7,229,590 shares of our common stock;

·                  the conversion of $22.1 million of outstanding principal and accrued interest on convertible notes into 3,679,401 shares of common stock, the write-off of $0.3 million of unamortized debt discount and the related repayment of $1.7 million of outstanding principal and accrued interest on convertible notes and accrued interest outstanding as of September 30, 2013;

·                  480,763 shares of our common stock became issuable pursuant to the redemption of an aggregate of 900,000 exchangeable shares of Fate Canada and the resultant reclassification of the $3.3 million exchangeable share liability to additional paid-in capital, of which $2.9 million was recorded as of September 30, 2013;

·                  the conversion of warrants to purchase 230,000 shares of convertible preferred stock into warrants to purchase 36,074 shares of our common stock and the resultant reclassification of the $0.2 million warrant liability to additional paid-in capital; and

·                  an amended and restated certificate of incorporation was filed on October 3, 2013 to authorize 150,000,000 shares of common stock and 5,000,000 shares of undesignated preferred stock.

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Financial Operations Overview

We conduct substantially all of our activities through Fate Therapeutics, Inc., a Delaware corporation, at our facility in San Diego, California. Fate Therapeutics, Inc. owns 100% of the voting shares of Fate Canada that were outstanding at September 30, 2013 and directs all of its operational activities, which are insignificant as compared to the operations of Fate Therapeutics, Inc. The following information is presented on a consolidated basis to include the accounts of Fate Therapeutics, Inc. and Fate Canada. All intercompany transactions and balances are eliminated in consolidation.

Revenue

To date, we have not generated any revenues from therapeutic product sales. Our revenues have been derived from collaboration activities and grant revenues.

Collaboration revenues are generated exclusively from our collaboration arrangement with Becton, Dickinson and Company, or BD. In September 2010, we entered into a worldwide exclusive license and collaboration agreement with BD for the joint development and worldwide commercialization of certain induced pluripotent stem cell, or iPSC, tools and technologies for use in drug discovery and development. The license and collaboration agreement was assigned by BD to Corning Incorporated in October 2012. In connection with the agreement, we received an upfront, non-refundable license payment, and are entitled to receive research funding for the conduct of joint development activities for a period of three years ending in September 2013. In addition, we are eligible to receive certain commercialization milestones and royalties on the sale of iPSC reagent products. In connection with the arrangement with BD, we recognized $0.2 million, $0.2 million, $0.6 million and $1.1 million for the three months ended September 30, 2013 and 2012 and the nine months ended September 30, 2013 and 2012, respectively, as collaboration revenue in our consolidated statements of operations. Our three-year joint development period under our license and collaboration agreement with BD concluded in September 2013. We do not currently anticipate generating any significant revenues associated with iPSC tools and technologies thereafter.

Grant revenue is primarily generated through research and development grant programs offered by the U.S. government and its agencies. In April 2011, we were awarded a $2.1 million grant from the U.S. Army Telemedicine & Advanced Technology Research Center, or TATRC, to identify and develop regenerative medicines for acute sound-inducing hearing loss. All funding under the TATRC grant was expended in full as of May 2013.

Research and Development Expenses

Research and development expenses consist of development costs associated with our platforms and programs. These costs are expensed as incurred and include:

·                  compensation and employee-related costs;

·                  costs associated with conducting our preclinical, clinical and regulatory activities, including fees paid to third-party professional consultants and service providers;

·                  costs incurred under clinical trial agreements with investigative sites;

·                  costs for laboratory supplies;

·                  costs to acquire, develop and manufacture preclinical study and clinical trial materials;

·                  charges associated with the achievement of certain preclinical and financial milestones pursuant to our asset acquisition of Verio Therapeutics Inc., or Verio, that was completed in April 2010; and

·                  facilities, depreciation and other expenses including allocated expenses for rent and maintenance of facilities.

From inception through September 30, 2013, we incurred $54.0 million in research and development expenses. We plan to increase our current level of research and development expenses for the foreseeable future as we continue the development of our stem cell modulation platforms and our initial therapeutic product candidates. Our current planned research and development activities include the following:

·                  advancing ProHema in a Phase 2 clinical trial in the setting of adult patients with orphan hematologic malignancies in 2014 to examine its safety and its curative potential in allogeneic hematopoietic stem cell transplant, or HSCT;

·                  initiating in 2014 a clinical trial of a pharmacologically-modulated HSC product candidate in pediatric patients with lysosomal storage disorders, or LSDs, to evaluate its safety and its curative potential in allogeneic HSCT; and

·                  conducting IND-enabling studies, filing an IND in 2014 and initiating a clinical trial of a Wnt7a protein analog product candidate to evaluate its safety and its potential to promote muscle regeneration.

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We cannot determine with certainty the timing of initiation, the duration and the completion costs of current or future preclinical studies and clinical trials of our therapeutic product candidates. At this time, due to the inherently unpredictable nature of preclinical and clinical development and given the early stage of our programs, we are unable to estimate with any certainty the costs we will incur and the timelines we will require in the continued development of our product candidates, including ProHema. Clinical and preclinical development timelines, the probability of success and development costs can differ materially from expectations. In addition, we cannot forecast which product candidates may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

The following table summarizes our research and development expenses by major programs for the periods indicated (in thousands):

We do not allocate general equipment and supply costs, or facilities, depreciation and other miscellaneous expenses to specific programs as these expenses are deployed across all of our programs.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and employee-related costs, including stock-based compensation and travel expenses for our employees in executive, operational, finance and human resource functions. Other general and administrative expenses include facility-related costs and professional fees for directors, accounting and legal services and expenses associated with obtaining and maintaining patents.

We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our continued research and development and potential commercialization of our product candidates. We also anticipate increased expenses related to audit, legal, regulatory, and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, director and officer insurance premiums, and investor relations costs associated with being a public company.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest income earned on cash and cash equivalents; interest expense on convertible notes and on amounts outstanding under our credit facility; changes in fair value of the exchangeable share liability relating to the total exchangeable shares held by the prior stockholders of Verio; and changes in fair value of the warrant liability relating to our outstanding preferred stock warrants.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expenses and the disclosure of contingent assets and liabilities in our financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses and stock-based compensation. We base our estimates on historical experience, known trends and events, and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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We discussed accounting policies and assumptions that involve a higher degree of judgment and complexity in our final prospectus dated September 30, 2013 filed with the SEC on October 1, 2013 pursuant to Rule 424(b) under the Securities Act in connection with our IPO. There have been no material changes to our critical accounting policies and estimates as disclosed in our final prospectus.

Results of Operations

Comparison of the Three Months Ended September 30, 2013 and 2012

The following table summarizes the results of our operations for the three months ended September 30, 2013 and 2012 (in thousands):

Revenue.  Total revenue was $0.2 million for the three months ended September 30, 2013, compared to $0.5 million for the three months ended September 30, 2012. The decrease of $0.3 million was due to the completion of our TATRC grant in May 2013.  Our three-year joint development period under our license and collaboration agreement with BD concluded in September 2013, and we do not expect to generate any significant revenue under this agreement thereafter.

Research and development expenses.  Research and development expenses were $3.4 million for the three months ended September 30, 2013, compared to $3.3 million for the three months ended September 30, 2012.  The $0.1 million increase in research and development expenses primarily reflects the following:

·                  $0.2 million increase in employee compensation and benefits expense to support the clinical development of ProHema and the preclinical development of our other product candidates;

·                  $0.6 million increase in non-employee stock-based compensation expense;

·                  $0.3 million non-cash charge relating to an increase in the number of shares of our common stock issuable upon the exchange of the exchangeable shares;

·                  $0.7 million decrease in third-party professional consultant and service provider expenses relating to the initiation of our ProHema-03 trial in December 2012, including expenses to support regulatory filing and other clinical start-up activities; and

·                  $0.3 million decrease in expenditures for laboratory equipment and supplies relating to the initiation and support of our ProHema-03 trial.

General and administrative expenses.  General and administrative expenses were $2.0 million for the three months ended September 30, 2013, compared to $0.9 million for the three months ended September 30, 2012.  The $1.1 million increase in general and administrative expenses primarily reflects the following:

·                  $0.2 million increase in employee compensation and benefits expense associated with the expansion of our executive management team;

·                  $0.4 million increase in non-employee stock-based compensation expense;

·                  $0.3 million increase in intellectual property related expenses; and

·                  $0.2 million increase in third-party professional consultant and service provider expenses to support our financial and legal preparedness as a public company.

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Other income (expense), net.  Other income (expense), net was $(0.9) million for the three months ended September 30, 2013, compared to $(0.5) million for the three months ended September 30, 2012.  The increase in other expense was primarily due to an increase in the fair value of the exchangeable share liability relating to the total exchangeable shares held by the former stockholders of Verio.

Comparison of the Nine Months Ended September 30, 2013 and 2012

The following table summarizes the results of our operations for the nine months ended September 30, 2013 and 2012 (in thousands):

Revenue.  Total revenue was $1.0 million for the nine months ended September 30, 2013, compared to $2.0 million for the nine months ended September 30, 2012. The decrease of $1.0 million was due to the completion of our TATRC grant in May 2013 and the receipt of a $0.5 million commercialization milestone payment in 2012 that did not recur in 2013 under our license and collaboration agreement with BD.  Our three-year joint development period under our agreement with BD concluded in September 2013, and we do not expect to generate any significant revenue under this agreement thereafter.

Research and development expenses.  Research and development expenses were $9.0 million for the nine months ended September 30, 2013, compared to $8.6 million for the nine months ended September 30, 2012.  The $0.4 million increase in research and development expenses primarily reflects the following:

·                  $1.0 million increase in employee compensation and benefits expense to support the clinical development of ProHema and the preclinical development of our other product candidates;

·                  $0.6 million increase in non-employee stock-based compensation expense;

·                  $0.3 million non-cash charge relating to an increase in the number of shares of our common stock issuable upon the exchange of the exchangeable shares;

·                  $0.8 million decrease in third-party professional consultant and service provider expenses relating to the conduct of our ProHema-02 trial during the first half of 2012 and the initiation of our ProHema-03 trial in December 2012, including expenses to support clinical trial conduct, regulatory filing and other clinical start-up activities; and

·                  $0.7 million decrease in expenditures for laboratory equipment and supplies relating to the initiation and support of our ProHema-03 trial and the conduct of our preclinical programs.

General and administrative expenses.  General and administrative expenses were $4.8 million for the nine months ended September 30, 2013, compared to $2.9 million for the nine months ended September 30, 2012.  The $1.8 million increase in general and administrative expenses primarily reflects the following:

·                  $0.6 million increase in employee compensation and benefits expense associated with the expansion of our executive management team;

·                  $0.4 million increase in non-employee stock-based compensation expense;

·                  $0.3 million increase in intellectual property related expenses; and

·                  $0.5 million increase in third-party professional consultant and service provider expenses, and other general expenses, to support our financial and legal preparedness as a public company.

Other income (expense), net.  Other income (expense), net was $(2.4) million for the nine months ended September 30, 2013, compared to $(0.6) million for the nine months ended September 30, 2012. The increase in other expense was primarily due to an increase in the fair value of the exchangeable share liability relating to the total exchangeable shares held by the former stockholders of Verio.

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Liquidity and Capital Resources

We have incurred losses and negative cash flows from operations since inception. As of September 30, 2013, we had an accumulated deficit of $80.8 million and anticipate that we will continue to incur net losses for the foreseeable future.

From our inception through September 30, 2013, we have funded our consolidated operations primarily through the private placement of preferred stock and convertible notes, commercial bank debt and revenues from collaboration activities and grants. As of September 30, 2013, we had cash and cash equivalents of approximately $19.1 million. As discussed above, our IPO and related transactions resulted in net proceeds of $40.0 million subsequent to September 30, 2013.

In 2009, we entered into a $3.0 million loan and security agreement collateralized by substantially all of our assets, excluding certain intellectual property. We drew the full $3.0 million available under the loan and security agreement in 2009. In August 2011, the loan and security agreement was amended to: (i) increase the available credit under the loan and security agreement to $4.0 million, (ii) add an additional payment upon maturity equal to 5% of the maximum loan amount and (iii) repay the remaining $0.6 million of outstanding principal related to the original $3.0 million loan. We accessed the full $4.0 million of available credit under the amended loan and security agreement by taking a term advance of $2.0 million in August 2011 and a term advance of $2.0 million in December 2011, each of which are scheduled to be fully paid by August 2014 and December 2014, respectively. The term advances require interest-only payments during the first 12 months from access and equal monthly principal and interest payments during the final 24 months from access. The interest rate on the term advances is fixed at 7.0% per annum for their entire 36-month term of the debt. As of September 30, 2013, the aggregate outstanding principal was $2.3 million.

The following table sets forth a summary of the net cash flow activity for each of the periods indicated (in thousands):

Operating Activities

Cash used in operating activities increased $0.9 million from $9.9 million for the nine months ended September 30, 2012 to $10.8 million for the nine months ended September 30, 2013. The primary driver of operating cash requirements was our net loss in each period. During the nine months ended September 30, 2012, we used cash from operating activities of $9.9 million while our net loss was $10.1 million. The difference was a result of $0.6 million net change in our operating assets and liabilities, offset by $0.8 million of non-cash charges and deferrals, including depreciation expense and stock-based compensation. During the nine months ended September 30, 2013, we used cash from operating activities of $10.8 million while our net loss was $15.2 million. The difference was a result of $0.4 million net change in our operating assets and liabilities and $4.0 million of non-cash charges and deferrals, including $0.4 million of depreciation expense, $1.2 million of stock-based compensation and $2.3 million related to the change in fair value of exchangeable shares.

Investing Activities

During the nine months ended September 30, 2012 and 2013, investing activities used cash of $0.4 million and $0.1 million, respectively, for the purchase of property and equipment.

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Financing Activities

Financing activities provided cash of $9.4 million for the nine months ended September 30, 2012 and provided cash of $20.9 million for the nine months ended September 30, 2013. During the nine months ended September 30, 2012, we received $9.2 million in net proceeds from the sale of Series C preferred stock. During the nine months ended September 30, 2013, we paid down principal of $1.5 million on our outstanding long-term debt. No principal amounts were paid down in 2012 as the debt was still in its interest-only period. In addition, we received $23.7 million of proceeds from the sale of convertible notes and paid $1.4 million for initial public offering costs during the nine months ended September 30, 2013.

Operating Capital Requirements

To date, we have not generated any revenues from therapeutic product sales. We do not know when, or if, we will generate any revenue from therapeutic product sales. We do not expect to generate significant revenue from therapeutic product sales unless and until we obtain regulatory approval of and commercialize one of our current or future product candidates. We anticipate that we will continue to incur losses for the foreseeable future, and we expect the losses to increase as we continue the development of, and seek regulatory approvals for, our product candidates, and begin to commercialize any approved products. We are subject to all of the risks incident in the development of new therapeutic products, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors that may adversely affect our business. We expect to incur additional costs associated with operating as a public company. We anticipate that we will need substantial additional funding in connection with our continuing operations.

We believe that the net proceeds from our IPO and our existing cash and cash equivalents will be sufficient to fund our projected operating requirements through at least the end of 2014. However, we may require additional capital for the further development of our existing product candidates and may also need to raise additional funds sooner to pursue other development activities related to additional product candidates.

Until we can generate a sufficient amount of revenue from our therapeutic products, if ever, we expect to finance future cash needs through public or private equity or debt offerings. In any event, we do not expect to achieve significant revenue from therapeutic product sales prior to the use of the net proceeds from our IPO. Additional capital may not be available on reasonable terms, if at all. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back or discontinue the development or commercialization of one or more of our product candidates. If we raise additional funds through the issuance of additional debt or equity securities, it could result in dilution to our existing stockholders, increased fixed payment obligations and the existence of securities with rights that may be senior to those of our common stock. If we incur indebtedness, we could become subject to covenants that would restrict our operations and potentially impair our competitiveness, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. Any of these events could significantly harm our business, financial condition and prospects.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. The amount and timing of future funding requirements, both near- and long-term, will depend on many factors, including, but not limited to:

·                  the design, initiation, progress, size, timing, costs and results of preclinical studies and clinical trials for our product candidates;

·                  the outcome, timing and cost of regulatory approvals by the FDA and comparable foreign regulatory authorities, including the potential for the FDA or comparable foreign regulatory authorities to require that we perform more studies than, or evaluate clinical endpoints other than those that we currently expect;

·                  the timing and costs associated with manufacturing our product candidates for clinical trials, preclinical studies and, if approved, for commercial sale;

·                  the number and characteristics of product candidates that we pursue;

·                  the extent to which we are required to pay milestone or other payments under our in-license agreements and the timing of such payments;

·                  the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;

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·                  our need to expand our research and development activities, including our need and ability to hire additional employees;

·                  our need to implement additional infrastructure and internal systems and hire additional employees as we operate as a public company;

·                  the effect of competing technological and market developments; and

·                  the cost of establishing sales, marketing and distribution capabilities for any products for which we may receive regulatory approval.

If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition and results of operations could be materially adversely affected.

Contractual Obligations and Commitments

The following table summarizes our contractual obligations and commitments as of December 31, 2012 that will affect our future liquidity (in thousands):