LISATA THERAPEUTICS, INC. - Quarter Report: 2010 June (Form 10-Q)

 

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

FOR THE QUARTERLY PERIOD ENDED June 30, 2010

OR

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

For the Transition Period from __________________   to _________________________

Commission File Number 0-10909

NEOSTEM, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		22-2343568
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
420 LEXINGTON AVE, SUITE 450 NEW YORK, NEW YORK		10170
(Address of principal executive offices)		(zip code)

Registrant’s telephone number, including area code: 212-584-4180

(Former name, former address and former fiscal year, if changed since last report)

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 x          No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes    o        No o

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

Large accelerated filer o	Accelerated filer o
Non-accelerated filer   o     (Do not check if a smaller reporting company)	Smaller reporting company x

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

57,001,543 SHARES, $.001 PAR VALUE, AS OF August 16, 2010

 

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INDEX

 

		Page No.
Part I  - Financial Information:
Item 1.	Consolidated Financial Statements (Unaudited):	3
	Consolidated Balance Sheets At June 30, 2010 and December 31, 2009	3
	Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009	4
	Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009	5
	Notes to Unaudited Consolidated Financial Statements	6-28
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29-38
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	39
Part II - Other Information:
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3.	Defaults Upon Senior Securities	44
Item 4.	Removed and Reserved	44
Item 5.	Other Information	44
Item 6.	Exhibits	44
	Signatures	45

 

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Item 1. Consolidated Financial Statements

NEOSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

		June 30,				December 31,
		2010				2009
ASSETS
Current Assets
Cash and cash equivalents		$	10,958,776			$	7,159,369
Short term investment			293,971				287,333
Restricted cash			4,096,265				4,714,610
Account receivable trade, less allowance for doubtful accounts			6,013,818				5,725,241
of $303,269 and $273,600, respectively
Inventories			16,381,569				12,979,008
Prepaids and other current assets			1,015,426				933,657
Total current assets			38,759,825				31,799,218
Property, plant and equipment, net			30,192,149				21,271,405
Land use rights, net			4,659,014				4,698,567
Goodwill			34,425,728				34,425,728
Intangible assets, net
Lease rights			460,462				633,136
Customer list, net			14,312,808				15,079,567
Other intangible assets, net			719,803				747,288
Total intangible assets, net			15,493,073				16,459,991
Other assets			317,842				238,941
		$	123,847,631			$	108,893,850
LIABILITIES AND EQUITY
Current liabilities
Accounts payable		$	9,350,135			$	8,263,718
Accrued liabilities			4,993,129				2,965,525
Bank loans			-				2,197,500
Notes payable			10,902,298				9,793,712
Unearned revenues			1,432,527				2,273,105
Total current liabilities			26,678,089				25,493,560
Long-term liabilities
Deferred tax liability			4,319,504				4,440,748
Unearned revenues			203,704				-
Amount due related party			7,855,238				7,234,291
COMMITMENTS AND CONTINGENCIES
Convertible Redeemable Series C Preferred stock;			-				13,720,048
8,177,512 shares designated, liquidation value $12.50 per share;
zero and 8,177,512 shares issued and outstanding at June 30, 2010
and December 31, 2009
EQUITY
Shareholders' Equity
Preferred stock; authorized, 20,000,000 shares			-				-
Series B convertible redeemable preferred stock			100				100
liquidation value, 1 share of common stock, $.01 par value;
825,000 shares designated; issued and outstanding,
10,000 shares at June 30, 2010 and December 31, 2009
Common stock, $.001 par value, authorized 500,000,000 shares			56,675				37,193
issued and outstanding, 56,675,496 at June 30, 2010
and 37,193,491 shares at December 31, 2009
Additional paid-in capital			129,485,735				95,709,491
Accumulated deficit			(81,839,591	)			(71,699,191	)
Accumulated other comprehensive income/(loss)			99,755				(67,917	)
Total shareholders' equity			47,802,674				23,979,676
Noncontrolling interests			36,988,422				34,025,527
Total equity			84,791,096				58,005,203
		$	123,847,631			$	108,893,850

 

See accompanying notes to consolidated financial statements

 

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NEOSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

Statement of Operations
		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
Revenues		$	19,407,523			$	31,600			$	35,240,702			$	76,738
Cost of revenues			12,911,800				15,750				23,763,418				39,300
Gross profit			6,495,723				15,850				11,477,284				37,438
Selling, general, and administrative			7,865,477				4,199,903				14,154,965				5,823,812
Research and development			2,133,172				515,264				3,433,542				769,892
Operating loss			(3,502,926	)			(4,699,317	)			(6,111,223	)			(6,556,266	)
Other income (expense):
Other income/(expense), net			149,571				12,389				(14,502	)			12,694
Interest expense			(6,198	)			(4,437	)			(14,717	)			(15,036	)
			143,373				7,952				(29,219	)			(2,342	)
Loss from operations before provision for income taxes and noncontrolling interests			(3,359,553	)			(4,691,365	)			(6,140,442	)			(6,558,608	)
Provision for income taxes			402,259				-				905,203				-
Net loss			(3,761,812	)			(4,691,365	)			(7,045,645	)			(6,558,608	)
Less - income from operations attributable to noncontrolling interests			1,611,501				-				2,940,154				-
Net loss attributable to controlling interests			(5,373,313	)			(4,691,365	)			(9,985,799	)			(6,558,608	)
Preferred dividends			53,771				251,727				153,469				251,727
Net loss attributable to common shareholders		$	(5,427,084	)		$	(4,943,092	)		$	(10,139,268	)		$	(6,810,335	)
Basic and diluted loss per share		$	(0.11	)		$	(0.62	)		$	(0.23	)		$	(0.86	)
Weighted average common shares outstanding			48,771,930				7,970,469				44,419,456				7,887,318

 

See accompanying notes to consolidated financial statements

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NEOSTEM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		For the Six Months Ended
		June 30,
Cash flows from operating activities:		2010				2009
Net loss		$	(7,045,645	)		$	(6,558,608	)
Adjustments to reconcile net loss to net cash used in
operating activities:
Common stock, stock options and warrants  issued
as payment for compensation and services rendered			4,339,693				1,758,574
Depreciation and amortization of intangible assets and prepaid land use rights			1,465,220				60,009
Loss on short term investments			34,717				-
Bad debt expense			28,176				-
Deferred tax liability			(121,244	)			-
Changes in operating assets and liabilities:
Prepaid expenses and other current assets			(78,895	)			(153,794	)
Accounts receivable			(286,184	)			(31,816	)
Inventories			(3,331,720	)			-
Unearned revenues			(647,749	)			112,557
Other assets			(78,900	)			-
Accounts payable and accrued expenses			2,258,073				(408,122	)
Net cash used in operating activities			(3,464,458	)			(5,221,200	)
Cash flows from investing activities:
Restricted cash released as collateral for bank loan			639,944				-
Purchase of short term investments			(2,430,388	)			-
Proceeds from the sale of short term investments			2,390,602				-
Acquisition of property and equipment			(8,634,298	)			(80,947	)
Net cash used in investing activities			(8,034,140	)			(80,947	)
Cash flows from financing activities:
Net proceeds from the exercise of warrants			2,493,750				-
Net proceeds from the exercise of options			140,100				-
Net proceeds from issuance of capital stock			13,565,504				-
Net proceeds from issuance of convertible redeemable preferred stock and warrants			-				15,669,220
Amounts due from a related party			375,135				(375,000	)
Payment of dividends			(222,922	)			-
Repayment of bank loan			(2,209,500	)			-
Repayment of notes payable			(9,988,213	)			(1,245,955	)
Proceeds from notes payable			11,046,833				1,284,753
Repayment of capitalized lease obligations			-				(12,126	)
Net cash provided by financing activities			15,200,687				15,320,892
Effect of exchange rates/changes on cash and cash equivalents			97,318				-
Net increase in cash and cash equivalents			3,799,407				10,018,745
Cash and cash equivalents at beginning of year			7,159,369				430,786
Cash and cash equivalents at end of year		$	10,958,776			$	10,449,531
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest		$	207,500			$	15,036
Income Taxes			999,800				-
Supplemental Schedule of non-cash investing activities
Acquisition of property and equipment		$	418,000				-
Capitalized interest			205,345				-
Supplemental Schedule of non-cash financing activities
Financing costs for capital stock raises			463,400				-
Conversion of Convertible Redeemable Series C Preferred stock			13,720,048				-

 

See accompanying notes to consolidated financial statements

 

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NEOSTEM, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1  – The Company

NeoStem, Inc. (“NeoStem” or the “Company”) was incorporated under the laws of the State of Delaware in September 1980 under the name Fidelity Medical Services, Inc.  The Company’s corporate headquarters is located at 420 Lexington Avenue, Suite 450, New York, NY 10170, its telephone number is (212) 584-4180 and its website address is www.neostem.com.

In 2009, through the Company’s expansion efforts within China and with the acquisition of a controlling interest in Suzhou Erye Pharmaceuticals Company Ltd. (“Erye”), the Company transitioned into a multi-dimensional international biopharmaceutical company with product and service revenues, global research and development capabilities and operations in three distinct business units: (i) U.S. adult stem cells, (ii) China adult stem cells, and (iii) China pharmaceuticals, primarily antibiotics. These business units are expected to provide platforms for the accelerated development and commercialization of innovative technologies and products in both the U.S. and China.

In the U.S., the Company is a leading provider of adult stem cell collection, processing and storage services enabling healthy individuals to donate and store their stem cells for personal therapeutic use. Similar to the banking of cord blood, pre-donating cells at a younger age helps to ensure a supply of one’s own stem cells should they be needed for future medical treatment. The Company’s current network of U.S. adult stem cell collection centers is focused primarily on the Southern California and Northeast markets. During 2010, the Company has begun to enter into new agreements for collection centers with the goal of expanding its coverage to ten centers by the end of 2010. Each collection center agreement is effectively a license that grants a physician practice the right to participate in the Company’s stem cell collection network and access to its stem cell banking technology, which includes its know-how, trade secrets, copy rights and other intellectual property rights owned by the Company and utilized in connection with the delivery of stem cell collection services.  The Company’s stem cell banking technology is proprietary and the subject of pending patent applications.  The terms of NeoStem’s collection center agreements are substantially similar. NeoStem grants to each physician practice serving as a collection center a non-exclusive license to use its trademarks and intellectual property but otherwise retains all rights thereto, and each collection center is bound by confidentiality obligations to NeoStem and non-competition provisions. NeoStem provides adult stem cell processing and storage services, as well as expertise and certain business, management and administrative services of a non-clinical nature in support of each physician practice serving as a collection center. In each case, the physician practice agrees that NeoStem will be its exclusive provider of adult stem cell processing and storage, management and other specified services. The agreements also make clear that since NeoStem is not licensed to practice medicine, NeoStem cannot and does not participate in clinical care or clinical decision making, both of which are exclusively the responsibility of the collection center (i.e., the responsibility of the physician or the medical practice).  The agreements provide for the payment to NeoStem by the collection center of specified fees that typically include upfront licensing fees and license maintenance fees.  As part of the licensing program, NeoStem also provides marketing and administrative support services. NeoStem does not have any equity or other ownership interest in any of the physician medical practices that serve as collection centers.  Each of the agreements is for a multi-year period, depending on the particular center, and typically has an automatic renewal provision for consecutive one year periods at the end of the initial term that also permits either party to terminate prior to renewal. The agreements may also relate to a territory from which patients seek collection services. The agreements contain insurance obligations and indemnification provisions, limitations on liability, non-compete provisions and other standard provisions. Generally, the agreements may be terminated by either party with prior written notice in the event of an uncured material breach by the other party and may be terminated by either party in the event of the other party’s bankruptcy, insolvency, receivership or other similar circumstances, or, depending on the agreement, certain other specified occurrences.

In 2009, the Company began several China-based, adult stem cell initiatives including: (i) creating a separate China-based stem cell collection and banking operation, (ii) constructing a stem cell research and development laboratory and processing facility in Beijing, (iii) establishing relationships with hospitals to provide stem cell-based therapies, and (iv) obtaining product licenses covering several adult stem cell therapeutics focused on regenerative medicine. In 2010, the Company, through an exclusive collaborator, began offering stem cell banking services and certain stem cell therapies to patients in Taiwan.

The cornerstone of the Company’s China pharmaceuticals business is the 51% ownership interest it acquired in Erye in October 2009. On October 30, 2009, China Biopharmaceuticals Holdings, Inc. (“CBH”) merged with and into CBH Acquisition LLC (“Merger Sub”), a wholly-owned subsidiary of NeoStem, with Merger Sub as the surviving entity (the “Merger”). As a result of the Merger, NeoStem acquired CBH’s 51% ownership interest in Erye, a Sino-foreign joint venture with limited liability organized under the laws of the People’s Republic of China.  Erye was founded more than 50 years ago and represents an established, vertically-integrated pharmaceutical business. Historically, Erye has concentrated its efforts on the manufacturing and distribution of generic antibiotic products and has received more than 160 production certificates from the State Food and Drug Administration of China (“SFDA”), covering both antibiotic prescription drugs and active pharmaceutical intermediates.

The results of operations for Erye are included in our consolidated results of operations beginning on October 30, 2009.  The results of operations for periods prior to October 30, 2009 reflect NeoStem as a stand-alone entity.

 

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Note 2 – Summary of Significant Accounting Policies

Principles of Consolidation: The consolidated financial statements include the accounts of NeoStem, Inc. (a Delaware corporation) and its wholly owned and partially owned subsidiaries and affiliates as listed below:

Entity		Percentage of Ownership		Location
NeoStem, Inc.		Parent  Company		United States of America
NeoStem Therapies, Inc.		100%		United States of America
Stem Cell Technologies, Inc.		100%		United States of America
NeoStem (China) Inc.		100%		People’s Republic of China
Qingdao Niao Bio-Technology Ltd.*		*		People’s Republic of China
Beijing Ruijiao Bio-Technology Ltd.*		*		People’s Republic of China
China Biopharmaceuticals Holdings, Inc. (Merger Sub)		100%		United States of America
Suzhou Erye Pharmaceuticals Company Ltd.		51% owned by Merger Sub		People’s Republic of China

* Because certain regulations in the People’s Republic of China (“PRC”) currently restrict or prohibit foreign entities from holding certain licenses and controlling certain businesses in China, the Company created a wholly foreign-owned entity, or WFOE, NeoStem (China), to implement its expansion initiatives in China. To comply with China’s foreign investment regulations with respect to stem cell-related activities, these business initiatives in China are conducted via two Chinese domestic entities, Qingdao Niao Bio-Technology Ltd., or Qingdao Niao, and Beijing Ruijieao Bio-Technology Ltd., or Beijing Ruijieao, that are controlled by the WFOE through various contractual arrangements and under the principles of consolidation the Company consolidates 100% of their operations.

Basis of Presentation: The consolidated balance sheet as of June 30, 2010, the consolidated statements of operations for the three amd six months ended June 30, 2010 and 2009, and the consolidated statements of cash flows for the six months ended June 30, 2010 and 2009 and related disclosures contained in the accompanying notes are unaudited. The consolidated balance sheet as of December 31, 2009 is derived from the audited consolidated financial statements included in the annual report filed on Form 10-K with the U.S. Securities and Exchange Commission (the “SEC”) as adjusted – see Note 4. The consolidated financial statements are presented on the basis of accounting principles that are generally accepted in the United States of America for interim financial information and in accordance with the instructions of the SEC on Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all the information and notes required by accounting principles generally accepted in the United States for a complete set of financial statements. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the consolidated balance sheet as of June 30, 2010 and the results of operations and cash flows for the periods ended June 30, 2010 and 2009 have been made. The results for the three and six months ended June 30, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010 or for any other period. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K filed with the SEC.

Certain reclassifications have been made to prior year amounts to conform to the current year presentation.  In particular, the Company reclassified short term investments at December 31, 2009 of $287,333 from Prepaid and other current assets to Short term investments.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period.  Accordingly, actual results could differ from those estimates.

Cash Equivalents: Short-term cash investments, which have a maturity of ninety days or less when purchased, are considered cash equivalents.

 

Concentration of Risks: For the three and six months ended June 30, 2010, two major suppliers provided approximately 23% of Erye’s purchases of raw materials with each supplier individually accounting for  13% and 10%, respectively. As of June 30, 2010, the total accounts payable to the two major suppliers was 24% of the total accounts payable.

 

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Foreign Exchange Risk:  Since 2005, the PRC government has followed a policy of establishing the value of the Renminbi on a basket of certain foreign currencies and as a result the value of the Renminbi has fluctuated within a narrow and managed band. However, the Chinese government has come under increasing U.S. and international pressure to revalue the Renminbi or to permit it to trade in a wider band, which many observers believe would lead to substantial appreciation of the Renminbi against the U.S. dollar and other major currencies. On June 19, 2010, the central bank of China announced that it will gradually modify its monetary policy and make the Renminbi’s exchange rate more flexible and allow the Renminbi to appreciate in value in line with its economic strength.  There can be no assurance that the Renminbi will be stable against the U.S. dollar. 

Economic and Political Risks:   The Company faces a number of risks and challenges since a significant amount of its assets are located in China and its revenues are derived primarily from its operations in China. China is a developing country with a young economic market system overshadowed by the state. Its political and economic systems are very different from the more developed countries and are still in the stage of change. China also faces many social, economic and political challenges that may produce major shocks and instabilities and even crises, in both its domestic arena and its relationship with other countries, including but not limited to the United States. Such shocks, instabilities and crises may in turn significantly and negatively affect the Company’s performance.

Approximately 70% of Erye’s sales are derived from products that use penicillin or cephalosporin as the key active ingredient. These products are manufactured on 2 of the 8 production lines in Erye’s manufacturing facility. Any issues or incidents that might disrupt the manufacturing of products requiring penicillin or cephalosporin could have a material impact on the operating results of Erye.

Restricted Cash:     Restricted cash represents cash required to be deposited with banks in China as collateral for the balance of bank notes payable and are subject to withdrawal restrictions according to the agreement with the bank. The required deposit rate is approximately 30-50% of the notes payable balance.

Accounts Receivable: Accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables. The Company applies judgment in connection with establishing the allowance for doubtful accounts. Specifically, the Company analyzes the aging of accounts receivable balances, historical bad debts, customer concentration and credit-worthiness, current economic trends and changes in the Company’s customer payment terms. Significant changes in customer concentrations or payment terms, deterioration of customer credit-worthiness or weakening economic trends could have a significant impact on the collectability of the receivables and the Company’s operating results. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Management regularly reviews the aging of receivables and changes in payment trends by its customers, and records a reserve when it believes collection of amounts due are at risk.

Inventories:   Inventories are stated at the lower of cost or market using the first-in, first-out basis. The Company reviews its inventory periodically and will reduce inventory to its net realizable value depending on certain factors, such as product demand, remaining shelf life, future marketing plans, obsolescence and slow-moving inventories.

 

 

		June 30,				December 31,
		2010				2009
Raw materials		$	7,020.6			$	6,338.8
Work in process			3,151.7				666.7
Finished goods			6,209.3				5,973.5
Total inventory		$	16,381.6			$	12,979.0

 

Property and Equipment: The cost of property and equipment is depreciated over the estimated useful lives of the related assets of 3 to 30 years. The cost of computer software programs are amortized over their estimated useful lives of five years. Depreciation is computed on the straight-line method. Repairs and maintenance expenditures that do not extend original asset lives are charged to expense as incurred.

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		June 30,				December 31,
		2010				2009
Building and Improvements		$	1,620.3			$	-
Machinery and Equipment			7,964.2				3,289.3
Lab Equipment			1,049.3				704.2
Furniture and Fixtures			322.2				273.2
Vehicles			264.0				75.3
Software			92.5				81.7
Leasehold Improvements			63.4				58.4
Construction in Progress			19,583.3				17,075.1
			30,959.2				21,557.2
Accumulated Depreciation			(767.1	)			(285.8	)
Total fixed assets		$	30,192.1			$	21,271.4

 

The Company’s results included depreciation expense of approximately $217,500 and $21,041 for the three months ended June 30, 2010 and 2009, respectively, and $476,900 and $41,799 for the six months ended June 30, 2010 and 2009, respectively.

Construction-In-Progress:   Construction-in-progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities. Interest incurred during the period of construction, if material, is capitalized. Construction-in-progress is not depreciated until the assets are completed and placed into service.

 

Erye is constructing a new factory and is in the process of relocating to the new facility as the project is completed. Construction in progress is related to this production facility and is being built in accordance with the PRC’s Good Manufacturing Practices (“GMP”) Standard. The Company expects that the construction will be completed in 2011, however, certain elements of the project have been completed and put into service in 2010.  The estimated additional cost to complete construction will be approximately $6 million.  No depreciation is provided for construction-in-progress until such time the assets are completed and placed into service.

As of June 30, 2010 and December 31, 2009, the Company had construction-in-progress which amounted to $19,583,294 and $17,075,057, respectively. As of June 30, 2010 and December 31, 2009, the Company had capitalized interest as part of construction-in-progress which amounted to $765,200 and $526,900, respectively.

 

Income Taxes: The Company recognizes (a) the amount of taxes payable or refundable for the current year and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an enterprise’s financial statement or tax returns. The Company continues to evaluate the accounting for uncertainty in tax positions.  The guidance requires companies to recognize in their financial statements the impact of a tax position if the position is more likely than not of being sustained on audit. The position ascertained inherently requires judgment and estimates by management.  For the three and six months ended June 30, 2010 and 2009, management does not believe the Company has any material uncertain tax positions that would require it to measure and reflect the potential lack of sustainability of a position on audit in its financial statements. The Company will continue to evaluate its uncertain tax positions in future periods to determine if measurement and recognition in its financial statements is necessary.  The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months.

 

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Comprehensive Income (Loss): The accumulated other comprehensive income/(loss) balance at June 30, 2010 and December 31, 2009 in the amount of $99,755 and $(67,917), respectively, is comprised entirely of cumulative losses resulting from foreign currency translation.  Comprehensive loss for the three and six months ended June 30, 2010 and 2009 was as follows (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
Net loss		$	(3,761.8	)		$	(4,691.4	)		$	(7,045.6	)		$	(6,558.6	)
Other comprehensive income (loss)
Foreign currency translation			154.5				-				167.7				-
Total other comprehensive income			154.5				-				167.7				-
Comprehensive loss			(3,607.3	)			(4,691.4	)			(6,877.9	)			(6,558.6	)
Comprehensive income attributable to the non-controlling interest			1,687.2				-				3,022.3				-
Comprehensive loss attributable to NeoStem		$	(5,294.5	)		$	(4,691.4	)		$	(9,900.2	)		$	(6,558.6	)

 

Goodwill: Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination. The Company reviews recorded goodwill for potential impairment annually or upon the occurrence of an impairment indicator. The Company performs its annual impairment test as of December 31 each year.   See Note 4.

Prepaid Land Use Rights:   According to Chinese law, the government owns all the land in China. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. Prepaid land use rights are recognized ratably over the lease term of 50 years.

Intangible Asset - patent rights: Accounting standards require purchased intangible assets other than goodwill to be amortized over their useful lives unless those lives are determined to be indefinite. Purchased intangible assets are carried at cost less accumulated amortization. Definite-lived intangible assets, which consist of patents and rights associated primarily with the VSEL™ Technology which constitutes the principal assets acquired in the acquisition of Stem Cell Technologies, Inc., have been assigned a useful life and are amortized on a straight-line basis over a period of nineteen years.

Intangible asset – product rights - approved Drugs:   The Company obtained various official registration certificates or official approvals for clinical trials representing patented pharmaceutical formulas. No amortization is recorded when the Company intends to and has the ability to sell the patent or formulas within two months; otherwise the patent costs will be subject to amortization over its estimated useful life which is generally fifteen years. Such costs comprise purchase costs of patented pharmaceutical formulas and costs incurred for patent application. Product rights are accounted for on an individual basis.

Impairment of Long-lived Assets:  The Company reviews long-lived assets and certain identifiable intangibles to be held and used for impairment on an annual basis and whenever events or changes in circumstances indicate that the carrying amount of an asset exceeds the fair value of the asset. If other events or changes in circumstances indicate that the carrying amount of an asset that the Company expects to hold and use may not be recoverable, the Company will estimate the undiscounted future cash flows expected to result from the use of the asset or its eventual disposition, and recognize an impairment loss. The impairment loss, if determined to be necessary, would be measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Accounting for Share-Based Payment Expense:   The Company records share-based payment expense at fair value.  The Company utilizes the Black-Scholes valuation method for determination of share-based payment expense.  The Company accounts for share-based payment transactions with non-employees in which services are received in exchange for the equity instruments based upon the fair value of the equity instruments issued.  Generally, the Company recognizes the fair value of share-based payment expense in net income on a straight-line basis over the requisite service period.  See Note 9.  For those awards that contain performance conditions, expense is generally recognized when the performance condition is deemed probable of occurring.

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
Revenues
Prescription Drugs and intermediary pharmaceutical products		$	19,351.3			$	-			$	35,122.5			$	-
Stem cell revenues			21.7				14.0				66.4				58.6
Other revenues			34.5				17.6				51.8				18.1
		$	19,407.5			$	31.6			$	35,240.7			$	76.7

 

Fair Value Measurements:   Fair value of financial assets and liabilities that are being measured and reported are defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market at the measurement date (exit price).  The Company is required to classify fair value measurements in one of the following categories:

Level 1 inputs which are defined as quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 inputs which are defined as inputs other than quoted prices included within Level 1 that are observable for the assets or liabilities, either directly or indirectly.

Level 3 inputs are defined as unobservable inputs for the assets or liabilities.  Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may effect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

 

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The Company determined the fair value of funds invested in short term investments, which are considered trading securities, to be level 1 inputs measured by quoted prices of the securities in active markets. The Company determined the fair value of funds invested in money market funds to be level 2 inputs, which does not entail material subjectivity because the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets. The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2010, and December 31, 2009 (in thousands):

		June 30, 2010
		Fair Value Measurements Using Fair Value Hierarchy
		Level 1				Level 2				Level 3
Money Market Funds			-			$	1.2				-
Short term investments		$	294.0				-				-
		December 31, 2009
		Fair Value Measurements Using Fair Value Hierarchy
		Level 1				Level 2				Level 3
Money Market Funds			-			$	1,031.0				-
Short term investments		$	287.3				-				-

Some of the Company’s financial instruments are not measured at fair value on a recurring basis but are recorded at amounts that approximate fair value due to their liquid or short-term nature, such as cash and cash equivalents, restricted cash, accounts receivable, accounts payable, and notes payable.

Foreign Currency Translation:   As the Company’s Chinese pharmaceutical business is a self-contained and integrated entity, and the Company’s Chinese stem cell business’ future cash flow is expected to be sufficient to service its additional financing requirements, the Chinese subsidiaries’ functional currency is the Renminbi (“RMB”), and the Company’s reporting currency is the US dollar.  Results of foreign operations are translated at the average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of each reporting period. Cash flows are also translated at average translation rates for the period, therefore, amounts reported on the consolidated statement of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheet.

This quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rate quoted by the People’s Bank of China.

Translation adjustments resulting from this process are included in accumulated other comprehensive income (loss) and amounted to $99,755 and $(67,917) as of June 30, 2010 and December 31, 2009, respectively. Assets and liabilities at June 30, 2010 were translated at 6.809 RMB to 1 US dollar and at December 31, 2009 assets and liabilities were translated at 6.835 RMB to 1 US dollar. The average translation rates applied to income statement accounts and the statement of cash flows for the three and six months ended June 30, 2010 were 6.833 and 6.835 RMB to 1 US dollar, respectively.  Since the CBH acquisition closed in October 2009 and significant China-based stem cell operations began after June 30, 2009, there was no translation required for the income statement accounts and the statement of cash flows for the three and six months ended June 30, 2009.

Research and Development Costs:     Research and development (“R&D”) expenses include salaries, benefits, and other headcount related costs, clinical trial and related clinical manufacturing costs, contract and other outside service fees including sponsored research agreements, and facilities and overhead costs. The Company expenses the costs associated with research and development activities when incurred.

Shipping and Handling Costs:   Shipping and handling costs are included in selling, general and administrative expense and were $121,103 and $269,395 for the three and six months ended June 30, 2010, respectively, and $0 for the three and six months ended June 30, 2009, respectively.

 

Statutory Reserves: Pursuant to laws applicable to entities incorporated in the PRC, the PRC subsidiaries are prohibited from distributing their statutory capital and are required to appropriate from PRC GAAP profit after tax to other non-distributable reserve funds. These reserve funds include one or more of the following: (i) a general reserve, (ii) an enterprise expansion fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits (i.e., 50% of the registered capital of the relevant company), the general reserve fund requires annual appropriation at 10% of after tax profit (as determined under accounting principles generally accepted in the PRC at each year-end); the appropriation to the other funds are at the discretion of the subsidiaries.

 

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The general reserve is used to offset extraordinary losses. Subject to approval by the relevant authorities, a subsidiary may, upon a resolution passed by the shareholders, convert the general reserve into registered capital provided that the remaining general reserve after the conversion shall be at least 25% of the registered capital of the subsidiary before the capital increase as a result of the conversion. The staff welfare and bonus reserve is used for the collective welfare of the employees of the subsidiary. The enterprise expansion reserve is for the expansion of the subsidiary’s operations and can also be converted to registered capital upon a resolution passed by the shareholders subject to approval by the relevant authorities. These reserves represent appropriations of the retained earnings determined in accordance with Chinese law, and are not distributable as cash dividends to the parent company, NeoStem.  Statutory reserves are $1,180,990 and $1,126,300 as of June 30, 2010 and December 31, 2009, respectively.

Relevant PRC statutory laws and regulations permit payment of dividends by the Company’s PRC subsidiaries only out of their accumulated earnings, if any, as determined in accordance with PRC accounting standards and regulations. As a result of these PRC laws and regulations, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets either in the form of dividends, loans or advances.  The restricted amount was $214,300 at June 30, 2010.

Note 3 – Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (the “FASB’) issued an amendment to the accounting and disclosure requirements for transfers of financial assets, which was effective January 1, 2010. The amendment eliminates the concept of a qualifying special-purpose entity, changes the requirements for derecognizing financial assets and requires enhanced disclosures to provide financial statement users with greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets.  The adoption of this standard did not have a material impact on the consolidated financial statements.