UNITED STATES
 SECURITIES AND EXCHANGE
COMMISSION
 
 Washington, D.C.
20549
 
 FORM 10-Q
 
 x
              QUARTERLY REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 FOR THE QUARTERLY PERIOD ENDEDJune 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.
      Employerincorporation 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.
YesxNoo
 
 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).
 YesoNoo
 
 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
      filero
              Accelerated fileroNon-accelerated
      filero(Do
      not check if a smaller reporting company)
              Smaller reporting
      companyx
 
 Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).
 YesoNox
 57,001,543SHARES, $.001 PAR VALUE, AS OFAugust 16, 2010
 
 (Indicate the number of shares
outstanding of each of the issuer's classes of common stock, as of the latest
practicable date)


INDEX
  Page No.Part I  - Financial
      Information:Item 1.
              Consolidated Financial Statements
      (Unaudited):
              3Consolidated Balance
      Sheets AtJune 30, 2010 and December 31,
      2009
              3Consolidated Statements of
      Operations for thethree and sixmonths endedJune 30,
      2010 and
      2009
              4Consolidated Statements of Cash
      Flows for thesixmonths endedJune 30, 2010and 2009
              5Notes to Unaudited Consolidated
      Financial Statements
              6-28Item 2.
              Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations
              29-38Item 3.
              Quantitative and Qualitative
      Disclosures About Market Risk
              39Item 4.
              Controls and
      Procedures
              39Part II - Other
      Information:Item 1.
              Legal
      Proceedings
              41Item 1A.
              Risk
Factors
              41Item 2.
              Unregistered Sales of Equity
      Securities and Use of Proceeds
              43Item 3.
              Defaults Upon Senior
      Securities
              44Item 4.
              Removed and
      Reserved
              44Item 5.
              Other
      Information
              44Item 6.
              Exhibits
              44Signatures
              45
  2
  PART I. FINANCIAL INFORMATION
 
 Item 1. Consolidated Financial
Statements
 
 NEOSTEM, INC. AND
SUBSIDIARIES
 CONSOLIDATED BALANCE
SHEETS
 (Unaudited)
 
 June 30,
                      
                      
                      December
31,2010
                      
                      
                      2009ASSETSCurrent
    AssetsCash and cash
      equivalents
                      
                      $
                      10,958,776
                      
                      
                      $
                      7,159,369Short term
      investment
                      
                      
                      293,971
                      
                      
                      
                      287,333Restricted
    cash
                      
                      
                      4,096,265
                      
                      
                      
                      4,714,610Account receivable trade, less
      allowance for doubtful accounts
                      
                      
                      6,013,818
                      
                      
                      
                      5,725,241of $303,269 and $273,600,
      respectivelyInventories
                      
                      
                      16,381,569
                      
                      
                      
                      12,979,008Prepaids and other current
      assets
                      
                      
                      1,015,426
                      
                      
                      
                      933,657Total current
      assets
                      
                      
                      38,759,825
                      
                      
                      
                      31,799,218Property, plant and equipment,
      net
                      
                      
                      30,192,149
                      
                      
                      
                      21,271,405Land use rights,
      net
                      
                      
                      4,659,014
                      
                      
                      
                      4,698,567Goodwill
                      
                      
                      34,425,728
                      
                      
                      
                      34,425,728Intangible assets,
      netLease
rights
                      
                      
                      460,462
                      
                      
                      
                      633,136Customer list,
      net
                      
                      
                      14,312,808
                      
                      
                      
                      15,079,567Other intangible assets,
      net
                      
                      
                      719,803
                      
                      
                      
                      747,288Total intangible assets,
      net
                      
                      
                      15,493,073
                      
                      
                      
                      16,459,991Other
assets
                      
                      
                      317,842
                      
                      
                      
                      238,941$
                      123,847,631
                      
                      
                      $
                      108,893,850LIABILITIES AND
      EQUITYCurrent
      liabilitiesAccounts
      payable
                      
                      $
                      9,350,135
                      
                      
                      $
                      8,263,718Accrued
      liabilities
                      
                      
                      4,993,129
                      
                      
                      
                      2,965,525Bank loans
                      
                      
                      -
                      
                      
                      
                      2,197,500Notes
    payable
                      
                      
                      10,902,298
                      
                      
                      
                      9,793,712Unearned
      revenues
                      
                      
                      1,432,527
                      
                      
                      
                      2,273,105Total current
      liabilities
                      
                      
                      26,678,089
                      
                      
                      
                      25,493,560Long-term
      liabilitiesDeferred tax
      liability
                      
                      
                      4,319,504
                      
                      
                      
                      4,440,748Unearned
      revenues
                      
                      
                      203,704
                      
                      
                      
                      -Amount due related
      party
                      
                      
                      7,855,238
                      
                      
                      
                      7,234,291COMMITMENTS AND
      CONTINGENCIESConvertible Redeemable Series C
      Preferred stock;
                      
                      
                      -
                      
                      
                      
                      13,720,0488,177,512 shares designated,
      liquidation value $12.50 per share;zero and 8,177,512 shares issued
      and outstanding at June 30, 2010and December 31,
      2009EQUITYShareholders'
      EquityPreferred stock; authorized,
      20,000,000 shares
                      
                      
                      -
                      
                      
                      
                      -Series B convertible redeemable
      preferred stock
                      
                      
                      100
                      
                      
                      
                      100liquidation 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, 2009Common stock, $.001 par value,
      authorized 500,000,000 shares
                      
                      
                      56,675
                      
                      
                      
                      37,193issued and outstanding, 56,675,496
      at June 30, 2010and 37,193,491 shares at December
      31, 2009Additional paid-in
      capital
                      
                      
                      129,485,735
                      
                      
                      
                      95,709,491Accumulated
      deficit
                      
                      
                      (81,839,591
                      )
                      
                      
                      (71,699,191
                      )Accumulated other comprehensive
      income/(loss)
                      
                      
                      99,755
                      
                      
                      
                      (67,917
                      )Total shareholders'
      equity
                      
                      
                      47,802,674
                      
                      
                      
                      23,979,676Noncontrolling
      interests
                      
                      
                      36,988,422
                      
                      
                      
                      34,025,527Total
equity
                      
                      
                      84,791,096
                      
                      
                      
                      58,005,203$
                      123,847,631
                      
                      
                      $
                      108,893,850
  See accompanying notes to consolidated
financial statements
  3
  NEOSTEM, INC. AND
SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF
OPERATIONS
 (Unaudited)
  Statement of
      OperationsThree Months Ended June
      30,
                
                
                Six Months Ended June
      30,2010
                
                
                2009
                
                
                2010
                
                
                2009Revenues
                
                $
                19,407,523
                
                
                $
                31,600
                
                
                $
                35,240,702
                
                
                $
                76,738Cost of
      revenues
                
                
                12,911,800
                
                
                
                15,750
                
                
                
                23,763,418
                
                
                
                39,300Gross
profit
                
                
                6,495,723
                
                
                
                15,850
                
                
                
                11,477,284
                
                
                
                37,438Selling, general, and
      administrative
                
                
                7,865,477
                
                
                
                4,199,903
                
                
                
                14,154,965
                
                
                
                5,823,812Research and
      development
                
                
                2,133,172
                
                
                
                515,264
                
                
                
                3,433,542
                
                
                
                769,892Operating
    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
                )
                
                
                12,694Interest
      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
                
                
                
                251,727Net 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
 
 4
  NEOSTEM, INC. AND
SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH
FLOWS
 (Unaudited)
  For the Six Months
      EndedJune 30,Cash flows from operating
      activities:
                                                                        
                                                                        2010
                                                                        
                                                                        
                                                                        2009Net
      loss
                                                                        
                                                                        $
                                                                        (7,045,645
                                                                        )
                                                                        
                                                                        $
                                                                        (6,558,608
                                                                        )Adjustments to reconcile net loss
      to net cash used inoperating
      activities:Common stock, stock options and
      warrants  issuedas payment for compensation and
      services rendered
                                                                        
                                                                        
                                                                        4,339,693
                                                                        
                                                                        
                                                                        
                                                                        1,758,574Depreciation and amortization of
      intangible assets and prepaid land use rights
                                                                        
                                                                        
                                                                        1,465,220
                                                                        
                                                                        
                                                                        
                                                                        60,009Loss 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
                                                                        )
                                                                        
                                                                        
                                                                        112,557Other
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
                                                                        
                                                                        
                                                                        -
                                                                        
                                                                        
                                                                        
                                                                        15,669,220Amounts 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
                                                                        
                                                                        
                                                                        
                                                                        1,284,753Repayment of capitalized lease
      obligations
                                                                        
                                                                        
                                                                        -
                                                                        
                                                                        
                                                                        
                                                                        (12,126
                                                                        )Net cash provided by financing
      activities
                                                                        
                                                                        
                                                                        15,200,687
                                                                        
                                                                        
                                                                        
                                                                        15,320,892Effect
      of exchange rates/changes on cash and cash equivalents
                                                                        
                                                                        
                                                                        97,318
                                                                        
                                                                        
                                                                        
                                                                        -Net increase in cash and cash
      equivalents
                                                                        
                                                                        
                                                                        3,799,407
                                                                        
                                                                        
                                                                        
                                                                        10,018,745Cash and cash equivalents at
      beginning of year
                                                                        
                                                                        
                                                                        7,159,369
                                                                        
                                                                        
                                                                        
                                                                        430,786Cash and cash equivalents at end
      of year
                                                                        
                                                                        $
                                                                        10,958,776
                                                                        
                                                                        
                                                                        $
                                                                        10,449,531Supplemental Disclosure of Cash
      Flow Information:Cash paid during the period
      for:Interest
                                                                        
                                                                        $
                                                                        207,500
                                                                        
                                                                        
                                                                        $
                                                                        15,036Income
Taxes
                                                                        
                                                                        
                                                                        999,800
                                                                        
                                                                        
                                                                        
                                                                        -Supplemental Schedule of non-cash
      investing activitiesAcquisition of property and
      equipment
                                                                        
                                                                        $
                                                                        418,000
                                                                        
                                                                        
                                                                        
                                                                        -Capitalized interest
                                                                        
                                                                        
                                                                        205,345
                                                                        
                                                                        
                                                                        
                                                                        -Supplemental Schedule of non-cash
      financing activitiesFinancing 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
  5
  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.
  6
  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
              
              LocationNeoStem,
    Inc.
              
              Parent  Company
              
              United States of
      AmericaNeoStem Therapies,
      Inc.
              
              100%
              
              United States of
      AmericaStem Cell Technologies,
      Inc.
              
              100%
              
              United States of
      AmericaNeoStem (China)
      Inc.
              
              100%
              
              People’s Republic of
      ChinaQingdao Niao Bio-Technology
      Ltd.*
              
              *
              
              People’s Republic of
      ChinaBeijing Ruijiao Bio-Technology
      Ltd.*
              
              *
              
              People’s Republic of
      ChinaChina Biopharmaceuticals Holdings,
      Inc. (Merger Sub)
              
              100%
              
              United States of
      AmericaSuzhou 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 ofJune 30, 2010, the consolidated statements of
operations for thethree amd sixmonths endedJune 30,
2010and 2009, and the
consolidated statements of cash flows for thesixmonths endedJune 30,
2010and 2009 and related
disclosures contained in the accompanying notes are unaudited. The consolidated
balance sheet as ofDecember 31, 2009is 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 ofJune 30, 2010and the results of operations and
cash flows for the periods endedJune 30, 2010and 2009 have been made. The
results for thethree and sixmonths endedJune 30,
2010are not necessarily
indicative of the results to be expected for the year
endingDecember 31, 2010or 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
endedDecember 31, 2010included 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
thethree and sixmonths endedJune 30,
2010, two major suppliers provided
approximately23%of
Erye’s purchases of raw materials with each supplier individually accounting
for13%and10%, respectively. As ofJune 30, 2010, the total
accounts payable to the two major suppliers was24%of the total accounts
payable.
  7
  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.
  Inventories consisted of the following
(in thousands):
  June 30,
                
                
                December
31,2010
                
                
                2009Raw
    materials
                
                $
                7,020.6
                
                
                $
                6,338.8Work in
    process
                
                
                3,151.7
                
                
                
                666.7Finished
    goods
                
                
                6,209.3
                
                
                
                5,973.5Total
    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.
 
 8
  Property and equipment consisted of the
following (in thousands):
  June 30,
                
                
                December
31,2010
                
                
                2009Building and
      Improvements
                
                $
                1,620.3
                
                
                $
                -Machinery and
      Equipment
                
                
                7,964.2
                
                
                
                3,289.3Lab
    Equipment
                
                
                1,049.3
                
                
                
                704.2Furniture and
      Fixtures
                
                
                322.2
                
                
                
                273.2Vehicles
                
                
                264.0
                
                
                
                75.3Software
                
                
                92.5
                
                
                
                81.7Leasehold
      Improvements
                
                
                63.4
                
                
                
                58.4Construction in
      Progress
                
                
                19,583.3
                
                
                
                17,075.130,959.2
                
                
                
                21,557.2Accumulated
      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 $21,041for thethreemonths endedJune 30,
2010and 2009, respectively,
and $476,900 and $41,799for thesixmonths endedJune 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$6million.No depreciation is provided
for construction-in-progress until such time the assets are completed and placed
into service.
 
 As ofJune 30, 2010andDecember 31, 2009, the Company had
construction-in-progress which amounted to $19,583,294and $17,075,057, respectively. As ofJune
30, 2010andDecember
31, 2009, the Company had
capitalized interest as part of construction-in-progress which amounted to
$765,200and
$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
thethree and sixmonths endedJune 30,
2010and 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.
  9
  Comprehensive Income
(Loss):The accumulated
other comprehensive income/(loss) balance atJune 30, 2010andDecember 31,
2009in the amount of
$99,755 and$(67,917), respectively, is
comprised entirely of cumulative losses resulting from foreign currency
translation.  Comprehensive loss for thethree and
sixmonths
endedJune 30, 2010and 2009 was as follows (in
thousands):
  Three Months Ended June
      30,
                
                
                Six Months Ended June
      30,2010
                
                
                2009
                
                
                2010
                
                
                2009Net 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 VSELTMTechnology
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.
 
 Earnings Per
Share: Basic
(loss)/earnings per share is based on the weighted effect of all common shares
issued and outstanding, and is calculated by dividing net (loss)/income
available to common shareholders by the weighted average shares outstanding
during the period. Diluted (loss)/earnings per share, which is calculated by
dividing net (loss)/income available to common shareholders by the weighted
average number of common shares used in the basic earnings per share calculation
plus the number of common shares that would be issued assuming conversion of all
potentially dilutive securities outstanding, is not presented as such
potentially dilutive securities are anti-dilutive in all periods presented. For
thethree and sixmonths endedJune 30,
2010and 2009, the Company
incurred net losses and therefore no common stock equivalents were utilized in
the calculation of earnings per share.  AtJune 30,
2010and 2009, the Company
excluded the following potentially dilutive securites:
  June 30,
    2010
                
                
                June 30,
    2009Stock
    Options
                
                
                11,842,214
                
                
                
                2,565,800Warrants
                
                
                18,027,028
                
                
                
                18,262,204Series D Convertible Redeemable
      Preferred Stock
                
                
                -
                
                
                
                12,932,510
  10
  Revenue
Recognition:  The
Company recognizes revenue from pharmaceutical and pharmaceutical intermediary
products sales when title has passed, the risks and rewards of ownership have
been transferred to the customer, the fee is fixed and determinable, and the
collection of the related receivable is probable which is generally at the time
of delivery.  The Company initiated the collection and banking of
autologous adult stem cells in the fourth quarter of 2006. The Company
recognizes revenue related to the collection and cryopreservation of autologous
adult stem cells when the cryopreservation process is completed which is
generally twenty four hours after cells have been collected. Revenue related to
advance payments of storage fees is recognized ratably over the period covered
by the advanced payments. The Company earns revenue, in the form of license
fees, from physicians seeking to establish autologous adult stem cell collection
centers. These license fees are typically billed upon signing of the collection
center agreement and qualification of the physician by the Company’s
credentialing committee and at various times during the term of license
agreement based on the terms of the specific agreement. During the quarter ended
June 30, 2009, the Company modified its revenue recognition policy relative to
these license fees to recognize such fees as revenues ratably over the
appropriate period of time to which the revenue element relates. Previously
these license fees were recognized in full when agreements were signed and the
physician had been qualified by the Company’s credentialing committee. This
modification in revenue recognition policy did not have a material impact on the
results of operations. The Company also receives licensing fees from a licensee
for use of its technology and knowledge to operate an adult stem cell banking
operation in China, which licensing fees are recognized as revenues ratably over
the appropriate period of time to which the revenue element relates. In
addition, the Company earns royalties for the use of its name and scientific
information in connection with its License and Referral Agreement with
Promethean Corporation (see “Related Party Transactions” below), which royalties
are recognized as revenue when they are received.
 
 Revenues for thethree and
sixmonths
endedJune 30, 2010and 2009 were comprised of the
following (in thousands):
 
 Three Months Ended June
      30,
              
              
              Six Months Ended June
      30,2010
              
              
              2009
              
              
              2010
              
              
              2009RevenuesPrescription Drugs and
      intermediary pharmaceutical products
              
              $
              19,351.3
              
              
              $
              -
              
              
              $
              35,122.5
              
              
              $
              -Stem cell
      revenues
              
              
              21.7
              
              
              
              14.0
              
              
              
              66.4
              
              
              
              58.6Other
    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.
  11
  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 ofJune 30, 2010, andDecember 31, 2009(in
thousands):
 
 June 30,
    2010Fair Value Measurements Using Fair
      Value HierarchyLevel 1
              
              
              Level 2
              
              
              Level 3Money Market
      Funds
              
              
              -
              
              
              $
              1.2
              
              
              
              -Short term
      investments
              
              $
              294.0
              
              
              
              -
              
              
              
              -December 31,
      2009Fair Value Measurements Using Fair
      Value HierarchyLevel 1
              
              
              Level 2
              
              
              Level 3Money 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 $99,755and
$(67,917) as
ofJune 30, 2010andDecember 31, 2009, respectively. Assets and liabilities
atJune 30, 2010 were
translated at6.809RMB to 1 US dollar and atDecember 31, 2009assets and liabilities were
translated at6.835RMB to 1 US dollar. The average translation rates applied to income statement
accounts and the statement of cash flows for thethree
and sixmonths
endedJune 30, 2010were6.833and6.835RMB to 1 US dollar,
respectively.  Since the CBH acquisition closed in October 2009 and
significant China-based stem cell operations began afterJune 30,
2009, there was no translation
required for the income statement accounts and the statement of cash flows for
thethree and sixmonths endedJune 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 $121,103and $269,395for thethree and sixmonthsendedJune 30, 2010, respectively, and $0 for the three and
six months endedJune 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 oftherelevant 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.
  12
  The general reserve is used to offset
extraordinary losses.Subject to approval by the relevant
authorities,asubsidiary may, upon a resolution
passed by the shareholders, convert the general reserve intoregisteredcapitalprovided that the remaining general
reserve after theconversion shall be at least 25% of the registered capital of the subsidiary
before the capital increase as aresultof 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 canalsobe converted toregisteredcapital upon a resolution passed by the
shareholderssubject 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
$1,180,990and
$1,126,300as
ofJune 30, 2010andDecember 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 atJune 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.
 
 In June 2009, the FASB amended the
existing accounting and disclosure guidance for the consolidation of variable
interest entities, which was effective January 1, 2010. The amended
guidance requires enhanced disclosures intended to provide users of financial
statements with more transparent information about an enterprise’s involvement
in a variable interest entity.  The adoption of this standard did not
have a material impact on the consolidated financial statements.
 
 In October 2009, the FASB issued an
Accounting Standard Update (“ASU”) No. 2009-13, which addresses the
accounting for multiple-deliverable arrangements to enable vendors to account
for products or services separately rather than as a combined unit and modifies
the manner in which the transaction consideration is allocated across the
separately identified deliverables. The ASU significantly expands the disclosure
requirements for multiple-deliverable revenue arrangements. The ASU will be
effective for the first annual reporting period beginning on or after
June 15, 2010, and may be applied retrospectively for all periods presented
or prospectively to arrangements entered into or materially modified after the
adoption date. Early adoption is permitted, provided that the guidance is
retroactively applied to the beginning of the year of adoption. The Company will
not early adopt this ASU.
 
 In January 2010, the FASB amended
the existing disclosure guidance on fair value measurements, which was effective
January 1, 2010, except for disclosures about purchases, sales, issuances,
and settlements in the roll forward of activity in Level 3 fair value
measurements, which is effective January 1, 2011. Among other things, the
updated guidance requires additional disclosure for the amounts of significant
transfers in and out of Level 1 and Level 2 measurements and requires certain
Level 3 disclosures on a gross basis. Additionally, the updates amend existing
guidance to require a greater level of disaggregated information and more robust
disclosures about valuation techniques and inputs to fair value measurements.
Since the amended guidance requires only additional disclosures, the adoption of
the provisions effective January 1, 2010 did not, and for the provisions
effective in 2011 will not, impact the Company’s financial position or results
of operations.
 
 In March
2010, the FASB ratified the EITF final consensus on Issue No. 08-9, “Milestone
Method of Revenue Recognition.” The guidance in this consensus allows the
milestone method as an acceptable revenue recognition methodology when an
arrangement includes substantive milestones. The guidance provides a definition
of substantive milestone and should be applied regardless of whether the
arrangement includes single or multiple deliverables or units of accounting. The
scope of this consensus is limited to the transactions involving milestones
relating to research and development deliverables. The guidance includes
enhanced disclosure requirements about each arrangement, individual milestones
and related contingent consideration, information about substantive milestones
and factors considered in the determination. The consensus is effective
prospectively to milestones achieved in fiscal years, and interim periods within
those years, after June 15, 2010. Early application and retrospective
application are permitted. The Company will not early adopt this EITF.  The
Company is evaluating the effect this standard will have upon
adoption.
 
 In April
2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-13
“Compensation – Stock Compensation”, which addresses the accounting for stock
options when denominating the exercise price of a share-based payment award in
the currency of the market in which the underlying equity security trades. A
share based payment award with an exercise price denominated in the currency of
market in which a substantial portion of the entity’s equity securities trades
shall not be considered to contain a condition that is not a market,
performance, or service condition. Therefore such an award shall not be
classified as a liability if it otherwise qualifies for equity classification.
This standard is effective in fiscal years beginning on or after December 15,
2010.  The Company is evaluating the effect this standard will have upon
adoption.
  13
  Note 4 –
Acquisitions
 On October 30, 2009, NeoStem
consummated the Merger pursuant to which CBH was merged with and into Merger
Sub, a wholly-owned subsidiary of NeoStem, with Merger Sub as the surviving
entity in accordance with the terms of the Agreement and Plan of Merger, dated
November 2, 2008, as amended (“Merger Agreement”) by and between NeoStem, Merger
Sub, CBH and China Biopharmaceuticals Corp., a wholly-owned subsidiary of CBH
(“CBC”).  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
specializes in the production and sales of pharmaceutical products, as well as
chemicals used in pharmaceutical products.  Erye, which was founded more
than 50 years ago, currently manufactures and has received more than 160
production certifications from the SFDA covering both antibiotic prescription
drugs and active pharmaceutical intermediaries.   Suzhou Erye
Economy and Trading Co. Ltd. (“EET”) owns the remaining 49% ownership interest
in Erye.  The Company and EET have negotiated a revised joint venture
agreement, which has been approved in principle by the PRC governmental
authorities.
 
 Pursuant to the terms of the Merger
Agreement, NeoStem issued an aggregate of 13,750,167 shares of its common stock,
with a fair value of $20,762,800, and 8,177,512 shares of Series C Convertible
Preferred Stock, with a fair value of $13,720,000, in exchange for outstanding
CBH securities.  In addition, the Company issued Class E warrants to
purchase 1,603,191 shares of NeoStem Common Stock, with a fair value of
$590,800, to replace warrants issued by CBH.
 
 The fair value of the identifiable net
assets acquired in the Merger was $34,904,200. The fair value of the equity
issued as consideration by NeoStem was $35,073,600 and the fair value of the
noncontrolling interests of Erye was $33,698,200. The goodwill that has been
created by this acquisition is reflective of the values and opportunities of
expanded access to healthcare in the People’s Republic of China, the designation
of certain antibiotics as essential medicines in China, and that a majority of
Erye’s antibiotics are on the central or provincial governments’ drug
formularies. Due to the structure of the transaction, none of the goodwill is
expected to be tax deductible.
 
 The summary of assets acquired and
liabilities assumed on October 30, 2009 is as follows (in
thousands):
  Cash & Restricted
      Cash
              
              $
              4,451.2Accounts
      Receivable
              
              
              6,199.5Inventories
              
              
              12,469.0Other Current
      Asset
              
              
              2,925.2Property, Plant &
      Equipment
              
              
              18,922.6Intangibles and land use
      rights
              
              
              20,905.9Goodwill
              
              
              33,867.6Accounts
      Payable
              
              $
              6,256.8Other
      Liabilities
              
              
              2,895.3Deferred Tax
      Liability
              
              
              4,720.8Notes
    Payable
              
              
              9,618.1Amounts due Related
      Party
              
              
              7,478.1
 
 The total cost of the acquisition has
been allocated to the assets acquired and the liabilities assumed based upon
their estimated fair values at the date of the acquisition.  The
estimated purchase price allocation is subject to revision based on additional
valuation work that is being conducted.  The final allocation is
pending the receipt of this valuation work and the completion of the Company’s
internal review, which is expected during fiscal 2010.
 
 A preliminary allocation of the
consideration transferred to the net assets of CBH was made as of the Merger
date.  During the sixmonths endedJune 30, 2010, the Company continued to review its
preliminary allocation of the purchase price associated with the Merger and made
the following retrospective adjustments as of the Merger
date:
 
 The Company determined that finished
goods inventory acquired in connection with the merger was incorrectly valued
and should have been increased by approximately $1,917,000 to step-up such
inventory to fair value at the Merger date.  Such finished goods
inventory has been sold through by December 31, 2009.  Therefore, at
December 31, 2009, there is no effect on the reported balance of inventories in
the consolidated balance sheets.
 
 The Company determined that the fair
value of the acquired customer list intangible asset was incorrectly valued by
approximately $1,700,000 due to the inclusion of future tax benefits that will
not be realized for local Chinese tax purposes in the Company’s estimates of
future cash flows used to value this intangible asset.
 
 The Company determined that it had
incorrectly accounted for the book/tax basis differences that arose in recording
the fair value of the net assets acquired in connection with the
Merger.  Such increases to fair value, while deductible for book
purposes, are not deductible for local Chinese tax purposes but require
recognition of the impact such non-deductibility will have on future tax
expense.  Specifically, the Company did not establish at the Merger
date deferred tax liabilities of approximately $4,720,800 for such book/tax
basis differences.
  14
  The Company evaluated the materiality of
these errors from both a qualitative and quantitative perspective and concluded
that these errors were immaterial to the consolidated financial statements taken
as a whole for the fiscal year ended December 31, 2009.  The effect of
these immaterial errors and related retrospective adjustments at December 31,
2009 and for the year then ended are summarized as follows (in thousands, except
share and per share amounts):
  As Previously
      Reported
              
              
              Adjustment
              
              
              As AdjustedConsolidated  Balance  SheetAssets:Current
      Assets
              
              $
              31,799.2
              
              
              $
              -
              
              
              $
              31,799.2Property, plant and
      equipment, net
              
              
              21,299.4
              
              
              
              (28.0
              )
              
              
              21,271.4Intangible
      AssetsGoodwill
              
              
              29,862.1
              
              
              
              4,563.6
              
              
              
              34,425.7Land use rights,
      net
              
              
              4,698.6
              
              
              
              -
              
              
              
              4,698.6Lease
      rights
              
              
              633.2
              
              
              
              -
              
              
              
              633.2Customer list,
      net
              
              
              16,756.1
              
              
              
              (1,676.5
              )
              
              
              15,079.6Other
      intanbilbles
              
              
              747.3
              
              
              
              -
              
              
              
              747.3Other
      assets
              
              
              238.9
              
              
              
              -
              
              
              
              238.9$
              106,034.8
              
              
              $
              2,859.1
              
              
              $
              108,893.9Liabilities and
      EquityCurrent
      liabilities
              
              $
              25,493.6
              
              
              $
              -
              
              
              $
              25,493.6Deferred tax
      liability
              
              
              -
              
              
              
              4,440.7
              
              
              
              4,440.7Amount due related
      party
              
              
              7,234.3
              
              
              
              -
              
              
              
              7,234.3Convertible redeemable
      Series C preferred stock
              
              
              13,720.0
              
              
              
              -
              
              
              
              13,720.0Preferred stock Series B
      convertible, redeemable
              
              
              0.1
              
              
              
              -
              
              
              
              0.1Common
      stock
              
              
              37.2
              
              
              
              -
              
              
              
              37.2Additional paid in
      capital
              
              
              95,709.5
              
              
              
              -
              
              
              
              95,709.5Accumulated
      deficit
              
              
              (70,878.8
              )
              
              
              (820.3
              )
              
              
              (71,699.1
              )Accumulated other
      comprehensive loss
              
              
              (67.9
              )
              
              
              -
              
              
              
              (67.9
              )Noncontrolling
      interests
              
              
              34,786.8
              
              
              
              (761.3
              )
              
              
              34,025.5Total
      equity
              
              
              59,586.9
              
              
              
              (1,581.6
              )
              
              
              58,005.3$
              106,034.8
              
              
              $
              2,859.1
              
              
              $
              108,893.9
  15
  Consolidated Statement of
      Operations
              
              As Previously
      Reported
              
              
              Adjustment
              
              
              As AdjustedRevenues
              
              $
              11,565.1
              
              
              $
              -
              
              
              $
              11,565.1Cost of
      revenues
              
              
              7,587.2
              
              
              
              1,917.0
              
              
              
              9,504.2Gross
profit
              
              
              3,977.9
              
              
              
              (1,917.0
              )
              
              
              2,060.9Research and
      development
              
              
              4,318.8
              
              
              
              -
              
              
              
              4,318.8Selling, general and
      administrative
              
              
              23,459.6
              
              
              
              (28.4
              )
              
              
              23,431.2Operating
    loss
              
              
              (23,800.5
              )
              
              
              (1,888.6
              )
              
              
              (25,689.1
              )Other income
      (expense):Other income/(expense),
      net
              
              
              (1.4
              )
              
              
              -
              
              
              
              (1.4
              )Interest
      expense
              
              
              (37.8
              )
              
              
              -
              
              
              
              (37.8
              )(39.2
              )
              
              
              -
              
              
              
              (39.2
              )Loss from operations before
      provision for income taxes and non-controlling
      interests
              
              
              (23,839.7
              )
              
              
              (1,888.6
              )
              
              
              (25,728.3
              )Provision for income
      taxes
              
              
              344.2
              
              
              
              (280.0
              )
              
              
              64.2Net loss
              
              
              (24,183.9
              )
              
              
              (1,608.6
              )
              
              
              (25,792.5
              )Less - Income from operations
      attributable to non-controlling interests
              
              
              1,088.6
              
              
              
              (788.2
              )
              
              
              300.4Net Loss attributable to
      controlling Interests
              
              
              (25,272.5
              )
              
              
              (820.4
              )
              
              
              (26,092.9
              )Preferred
      dividends
              
              
              5,612.0
              
              
              
              -
              
              
              
              5,612.0Net loss attributable to common
      shareholders
              
              $
              (30,884.5
              )
              
              $
              (820.4
              )
              
              $
              (31,704.9
              )Basic and diluted loss per
      share
              
              $
              (2.37
              )
              
              
              
              
              
              $
              (2.44
              )Weighted average common shares
      outstanding
              
              
              13,019,518
              
              
              
              
              
              
              
              13,019,518
  Consolidated Statement of
      Equity
              
              As Previously
      Reported
              
              
              Adjustment
              
              
              As AdjustedPreferred stock Series B
      convertible, redeemable
              
              $
              0.1
              
              
              $
              -
              
              
              $
              0.1Common
      stock
              
              
              37.2
              
              
              
              -
              
              
              
              37.2Additional paid in
      capital
              
              
              95,709.5
              
              
              
              -
              
              
              
              95,709.5Accumulated
      deficit
              
              
              (70,878.8
              )
              
              
              (820.3
              )
              
              
              (71,699.1
              )Accumulated other
      comprehensive loss
              
              
              (67.9
              )
              
              
              -
              
              
              
              (67.9
              )Noncontrolling
      interests
              
              
              34,786.8
              
              
              
              (761.3
              )
              
              
              34,025.5Total
      equity
              
              $
              59,586.9
              
              
              $
              (1,581.6
              )
              
              $
              58,005.3
 
 16
  Consolidated Statement of Cash
      Flow
                
                As Previously
      Reported
                
                
                Adjustment
                
                
                As AdjustedCash flows from operating
      activities:Net loss
                
                $
                (24,183.9
                )
                
                $
                (1,608.6
                )
                
                $
                (25,792.5
                )Adjustments to reconcile net loss
      to net cash used in  operating
activities:
                
                
                -
                
                
                
                -
                
                
                
                -Common Stock, stock options and
      warrants  issuedas payment for compensation,
      services rendered and interest expense
                
                
                12,324.0
                
                
                
                -
                
                
                
                12,324.0Depreciation and
      amortization
                
                
                577.0
                
                
                
                (28.4
                )
                
                
                548.6Bad debt
      expense
                
                
                (90.2
                )
                
                
                -
                
                
                
                (90.2
                )Deferred tax
      liability
                
                
                -
                
                
                
                (280.0
                )
                
                
                (280.0
                )Realization of step-up in basis of
      inventory received at date of acquisition
                
                
                -
                
                
                
                1,917.0
                
                
                
                1,917.0Changes in operating assets and
      liabilities:Prepaid expenses and other current
      assets
                
                
                1,796.7
                
                
                
                -
                
                
                
                1,796.7Accounts
      receivable
                
                
                571.7
                
                
                
                -
                
                
                
                571.7Inventory
                
                
                (2,427.1
                )
                
                
                -
                
                
                
                (2,427.1
                )Other
assets
                
                
                (238.9
                )
                
                
                -
                
                
                
                (238.9
                )Unearned
      revenues
                
                
                1,991.8
                
                
                
                -
                
                
                
                1,991.8Payments to related
      party
                
                
                (243.8
                )
                
                
                -
                
                
                
                (243.8
                )Accounts payable, accrued
      expensesand other current
      liabilities
                
                
                1,274.7
                
                
                
                -
                
                
                
                1,274.7Net cash used in operating
      activities
                
                
                (8,648.0
                )
                
                
                -
                
                
                
                (8,648.0
                )Cash received in connection with
      acquisition of technology
                
                
                -Cash associated with
      Merger
                
                
                696.5
                
                
                
                -
                
                
                
                696.5Acquisition of property and
      equipment
                
                
                (2,387.6
                )
                
                
                -
                
                
                
                (2,387.6
                )Net cash used in investing
      activities
                
                
                (1,691.1
                )
                
                
                -
                
                
                
                (1,691.1
                )Net proceeds from issuance of
      Series D Preferred Stock
                
                
                15,669.2
                
                
                
                -
                
                
                
                15,669.2Proceeds from bank
      loan
                
                
                2,197.5
                
                
                
                -
                
                
                
                2,197.5Restricted cash pledged as
      collateral for bank loan
                
                
                (959.9
                )
                
                
                -
                
                
                
                (959.9
                )Proceeds from notes
      payable
                
                
                2,918.3
                
                
                
                -
                
                
                
                2,918.3Payment of capitalized lease
      obligations
                
                
                (14.7
                )
                
                
                -
                
                
                
                (14.7
                )Proceeds from sale of convertible
      debentures
                
                
                (2,742.7
                )
                
                
                -
                
                
                
                (2,742.7
                )Net cash provided by financing
      activities
                
                
                17,067.7
                
                
                
                -
                
                
                
                17,067.7Net increase in
      cash
                
                
                6,728.6
                
                
                
                -
                
                
                
                6,728.6Cash and cash equivalents at
      beginning of year
                
                
                430.8
                
                
                
                -
                
                
                
                430.8Cash and cash equivalents at end
      of year
                
                $
                7,159.4
                
                
                $
                -
                
                
                $
                7,159.4
  17
  Presented below is the unaudited
proforma information as if the acquisition had occurred at the beginning of
thethree and sixmonths endedJune 30,
2009along with a comparison
to the reported results for thethree and sixendedJune 30,
2010(in thousands, except
share and per share amounts):
  Three Months Ended June
      30,
              
              
              Six Months Ended June
      30,2010
              
              
              2009
              
              
              2010
              
              
              2009(As
    Reported)
              
              
              (Proforma)
              
              
              (As
    Reported)
              
              
              (Proforma)Revenues
              
              $
              19,407.5
              
              
              $
              15,420.8
              
              
              $
              35,240.7
              
              
              $
              28,111.6Cost of
      revenues
              
              
              12,747.9
              
              
              
              10,141.5
              
              
              
              23,599.5
              
              
              
              18,865.0Gross
profit
              
              
              6,659.6
              
              
              
              5,279.3
              
              
              
              11,641.2
              
              
              
              9,246.6Research and
      development
              
              
              2,133.2
              
              
              
              777.5
              
              
              
              3,433.5
              
              
              
              1,042.6Selling, general and
      administrative
              
              
              8,029.4
              
              
              
              5,703.9
              
              
              
              14,318.9
              
              
              
              9,050.5Operating
    loss
              
              
              (3,503.0
              )
              
              
              (1,202.1
              )
              
              
              (6,111.2
              )
              
              
              (846.5
              )Other income/(expense),
      net
              
              
              143.4
              
              
              
              41.2
              
              
              
              (29.2
              )
              
              
              (14.7
              )Loss from operations before
      provision for income taxes and noncontrolling
    interests
              
              
              (3,359.5
              )
              
              
              (1,160.9
              )
              
              
              (6,140.4
              )
              
              
              (861.2
              )Provision for income
      taxes
              
              
              402.3
              
              
              
              452.6
              
              
              
              905.2
              
              
              
              862.3Net loss
              
              
              (3,761.9
              )
              
              
              (1,613.5
              )
              
              
              (7,045.6
              )
              
              
              (1,723.5
              )Less - income from operations
      attributable to noncontrolling interests
              
              
              1,611.4
              
              
              
              1,508.1
              
              
              
              2,940.2
              
              
              
              2,428.6Preferred
      dividends
              
              
              53.8
              
              
              
              251.7
              
              
              
              153.5
              
              
              
              251.7Net loss attributable to common
      shareholders
              
              $
              (5,427.1
              )
              
              $
              (3,377.3
              )
              
              $
              (10,139.3
              )
              
              $
              (4,403.8
              )Weighted average common shares
      outstanding
              
              
              48,771,930
              
              
              
              21,840,823
              
              
              
              44,419,456
              
              
              
              21,923,974Net loss per
      share
              
              $
              (0.11
              )
              
              $
              (0.15
              )
              
              $
              (0.23
              )
              
              $
              (0.20
              )
  The unaudited supplemental pro forma
financial information should not be considered indicative of the results that
would have occurred if the Merger had been consummated on January 1, 2009, nor
are they indicative of future results.
 
 Note 5 – Intangible
Asset
 AtJune 30, 2010, the Company’s intangible assets
consisted of patent applications and rights associated with the VSEL TM
Technology which constitutes the principal assets acquired in the acquisition of
Stem Cells Technologies, Inc., patent rights owned by Erye, a lease right
between Erye and EET (the 49% shareholder of Erye) for the use of Erye’s current
manufacturing plant in Suzhou and Erye’s customer list.
 
 As ofJune 30, 2010andDecember 31, 2009, the Company’s intangible assets and
related accumulated amortization consisted of the following (in
thousands):
 
 June 30,
    2010
              
              
              December 31,
      2009Useful Life
              
              
              Gross
              
              
              Accumulated
      Amortization
              
              
              Net
              
              
              Gross
              
              
              Accumulated
      Amortization
              
              
              NetIntangible assets obtained in the
      CBH acquisitionLease
rights
              
              
              2
              
              
              $
              690.7
              
              
              $
              (230.2
              )
              
              $
              460.5
              
              
              $
              690.7
              
              
              $
              (57.6
              )
              
              $
              633.1Customer
    list
              
              
              10
              
              
              
              15,335.1
              
              
              
              (1,022.3
              )
              
              
              14,312.8
              
              
              
              15,335.1
              
              
              
              (255.6
              )
              
              
              15,079.5Patents
              
              
              5
              
              
              
              150.3
              
              
              
              (11.5
              )
              
              
              138.8
              
              
              
              150.3
              
              
              
              (2.7
              )
              
              
              147.6Intangible assets obtained in the
      Stem Cell Technologies, Inc. Acquisition
              
              
              
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -VSEL patent
      rights
              
              
              19
              
              
              
              669.0
              
              
              
              (88.0
              )
              
              
              581.0
              
              
              
              672.8
              
              
              
              (73.1
              )
              
              
              599.7Total Intangible
      Assets
              
              
              
              
              
              $
              16,845.1
              
              
              $
              (1,352.0
              )
              
              $
              15,493.1
              
              
              $
              16,848.9
              
              
              $
              (389.0
              )
              
              $
              16,459.9
  Estimated amortization expense for the
five years subsequent to June 30, 2010 is as follows (in
thousands):
  Years Ending December
      31,2010
                
                $
                966.02011
                
                
                1,872.82012
                
                
                1,585.12013
                
                
                1,585.12014
                
                
                1,585.1Thereafter
                
                
                7,899.0
  18
  The remaining weighted-average
amortization period as of December 31, 2009 is 8 years.
 
 Note 6– Accrued
Liabilities
 
 Accrued liabilities are as follows (in
thousands):
  June 30,
    2010
                
                
                December 31,
      2009Income taxes
      payable
                
                $
                1,901.3
                
                
                $
                1,842.0Patent
      infringement
                
                
                743.6
                
                
                
                -VAT payable
                
                
                586.5
                
                
                
                -Salaries and related
      taxes
                
                
                206.3
                
                
                
                531.6Professional
      fees
                
                
                242.3
                
                
                
                116.8Franchise
    taxes
                
                
                18.0
                
                
                
                139.0Collection
    cost
                
                
                84.9
                
                
                
                85.2Dividends
      payable
                
                
                -
                
                
                
                69.4Rent
expense
                
                
                73.7
                
                
                
                69.1Warrant
      liability
                
                
                30.6
                
                
                
                36.0Benefits
      Payable
                
                
                78.0
                
                
                
                -Security
      deposits
                
                
                250.9
                
                
                
                -Freight
      insurance
                
                
                76.0
                
                
                
                -Accrued construction
      costs
                
                
                418.1
                
                
                
                -Other
                
                
                282.9
                
                
                
                76.4$
                4,993.1
                
                
                $
                2,965.5
 
 Note 7 – Notes Payable and Bank
Loan
 In
December 2009, in order to facilitate  working capital requirements in
China, NeoStem (China) issued a promissory note to the Bank of Rizhao Qingdao
Branch in the amount of 4,400,000 RMB (approximately $645,480). The note bears
an interest rate of 4.05%. The note was repaid in the second quarter of 2010.
The loan was collateralized by cash in a restricted bank account totaling
5,189,400 RMB (approximately $759,200) and these funds were returned when the
note was repaid. In addition, in January 2010 NeoStem (China) entered into a
pledge agreement with the bank pledging all of its interest in its Variable
Interest Entities (“VIEs”) as additional collateral for the loan.
 
 On May
25, 2010 NeoStem (China) issued a promissory note to the Bank of Rizhao Qingdao
Branch in the amount of 3,600,000 RMB (approximately $530,300) due November 25,
2010 and bearing interest at 4.86% per annum.  The loan is collateralized
by cash in a restricted bank account totaling 4,074,500 RMB (approximately
$600,200). In addition, in May 2010 NeoStem (China) entered into a pledge
agreement with the bank pledging all of its interest in its VIEs as additional
collateral for the loan.
 
 The Company’s subsidiary Erye
has69,749,400RMB
(approximately $10,274,100)
of notes payables as ofJune 30, 2010. Notes are payables to the banks who
issue bank notes to Erye’s creditors. Notes payable are interest free and
usually mature after a three to six month period.  In order to issue
notes payable on behalf of Erye, the banks required collateral, such as cash
deposits which were approximately 30%-50% of notes to be issued, or properties
owned by Erye. Restricted cash put up for collateral for the balance of notes
payable atJune 30, 2010andDecember 31, 2009, amounted
to23,743,500RMB  (approximately $3,496,100) and26,999,300RMB (approximately
$3,955,400),
respectively.  AtJune 30, 2010andDecember 31,
2009the restricted cash
amounted to33.1% and40.4% of the notes payable
Erye issued, and the remainder of the notes payable is collateralized by
pledging the land use right Erye owns, which amounts to approximately
$1,907,200atJune 30, 2010andDecember 31, 2009, respectively.
 
 The
Company has financed certain insurance polices and has notes payable at June 30,
2010 in the amount of $97,900 related to these policies. These notes require
monthly payments and mature in less than one year.
    Note 8 – Convertible Redeemable Series C
Preferred Stock
 On October 30, 2009, pursuant to the
terms of the Merger Agreement, the Company issued 8,177,512 shares of Series C
Convertible Preferred Stock (“Series C Preferred Stock”) to RimAsia Capital
Partners, L.P. (“RimAsia”) in exchange for certain outstanding CBH
securities.
  19
  On May 17, 2010, RimAsia at its
option, converted its 8,177,512 shares of Series C Preferred Stock into
9,086,124 shares of the Company's common stock at a conversion rate of 0.90
shares of Series C Preferred Stock for 1.0 share of the Company’s common
stock. Following this
conversion, there are no shares of Series C Preferred Stock outstanding and
RimAsia will not be entitled to receive any dividends on such shares, to receive
notices or to vote such shares or to exercise or to enjoy any other powers,
preferences or rights in respect thereof; provided however that RimAsia was
entitled to receive a cash payment of $153,469 which is equal to the dividends
accrued but unpaid through from January 1, 2010 to May 17, 2010. This payment
was made on May 25, 2010.
 
 Note 9 – Shareholders’
Equity
 
 Common Stock:
 
 The authorized common stock of the
Company is 500 million shares, par value $0.001 per share.
 
 On February 18, 2010, the Company
completed a public offering of its common stock, selling 5,750,000 shares priced
at $1.35 per share. The Company received approximately $6,821,600 in net
proceeds from the offering, after underwriting discounts, commissions and
expenses, of approximately $940,000 of which approximately $463,000 was unpaid
as of June 30, 2010.
 
 Effective March 15, 2010, RimAsia
exercised a warrant to purchase 1,000,000 shares of restricted Common
Stock.  This warrant was  issued to RimAsia in a private
placement completed by the Company in September 2008.  The exercise
price was $1.75 per share, resulting in proceeds to the Companyof$1,750,000.  In connection
therewith, the Company modified certain terms of RimAsia’s Series D Warrant to
purchase 4,000,000 shares of Common Stock.  See Note 9 – Shareholders’
Equity - Warrants.
 
 On
May 17, 2010, RimAsia, the holder of 8,177,512 shares of Series C Preferred
Stock issued by the Company in connection with the Merger, at its option,
converted its 8,177,512 shares of Series C Preferred Stock into 9,086,124 shares
of the Company's common stock at a conversion rate of 0.90 shares of Series C
Preferred Stock for 1.0 share of the Company’s common stock.
 
 On May
19, 2010, the Company entered into a Common Stock Purchase Agreement with
Commerce Court Small Cap Value Fund, Ltd., which provides that, subject to
certain terms and conditions, Commerce Court is committed to purchase up to
$20,000,000 worth of shares of the Company’s common stock over a term of
approximately 24 months.  The Purchase Agreement provides that at the
Company’s discretion, it may present Commerce Court with draw down notices under
this $20 million equity line of credit arrangement from time to time, to
purchase the Company’s Common Stock, provided certain price requirements are met
and limited to 2.5% of the Company’s market capitalization at the time of such
draw down, which may be waived or modified.  The per share purchase
price for these shares will equal the daily volume weighted average price of the
Company’s common stock on each date during the draw down period on which shares
are purchased, less a discount of 5.0%.  The Purchase Agreement also
provides that the Company in its sole discretion may grant Commerce Court the
right to exercise one or more options to purchase additional shares of Common
Stock during each draw down period at a price which would be based on a discount
calculated in the same manner as it is calculated in the draw down notice. The
issuance of shares of common stock to Commerce Court pursuant to the Purchase
Agreement, and the sale of those shares from time to time by Commerce Court to
the public, are covered by an effective registration statement on Form S-3 filed
with the SEC.
 
 On May
27, 2010, the Company presented Commerce Court with a Draw Down
Notice.  Pursuant to the Purchase Agreement, the shares were offered
at a discount price to Commerce Court mutually agreed upon by the parties under
the Purchase Agreement equal to 95.0% of the daily volume weighted average price
of the common stock during the Pricing Period or a 5%
discount.  Pursuant to the Draw Down Notice, the Company also granted
Commerce Court the right to exercise one or more options to purchase additional
shares of common stock during the Pricing Period, based on the trading price of
the common stock.The
Company settled with Commerce Court on the purchase of 685,226 shares of common
stock under the terms of the Draw Down Notice and the Purchase Agreement at an
aggregate purchase price of $1.8 million, or approximately $2.63 per share,
on June 7, 2010.  The Company and Commerce Court agreed to waive the
minimum threshold price of $3.00 per share set forth in the Purchase
Agreement.  The Company received net proceeds from the sale of these shares
of approximately $1.7 million after deducting its offering
expenses.
 
 On June
1, 2010, Fullbright exercised a warrant to purchase 400,000 shares of restricted
Common Stock.  This
warrant was issued to Fullbright in a private placement of securities by the
Company in November 2008.  The exercise price was $1.75 per share,
resulting in proceeds to the Company of $700,000.
 
 On June
25, 2010, the Company entered into definitive securities purchase agreements
with investors in a registered direct public offering offering, pursuant to
which such investors agreed to purchase, and the Company agreed to sell, an
aggregate of 2,325,582 Units, consisting of an aggregate of 2,325,582 shares of
common stock and warrants to purchase an aggregate of 581,394 shares of common
stock.  The offering closed on June 30, 2010 with gross proceeds of
$5.0 million.  Each Unit was priced at $2.15 and consisted of one
share of common stock and a warrant which will allow the investor to purchase
0.25 shares of common stock at a per share price of $2.75.  The
warrants may be called by the Company in the event that the common stock trades
over $4.50 per share for 10 consecutive trading days.  Subject to
certain ownership limitations, the warrants will be exercisable on the date of
the closing and will expire 2 years thereafter.  The number of shares
of common stock issuable upon exercise of the warrants and the exercise price of
the warrants are adjustable in the event of stock dividends, splits,
recapitalizations, reclassifications, combinations or exchanges of shares,
reorganizations, liquidations, consolidation, acquisition of the Company
(whether through merger or acquisition of substantially all the assets or stock
of the Company) or similar events.  The issuance of the securities in
this offering was registered on a registration statement on Form S-3 filed with
the SEC.  Rodman & Renshaw LLC acted as the Company’s placement
agent in this offering and received a total payment of $340,000 in fees and
expenses and Placement Agent Warrants to purchase up to 93,023 shares of our
Common Stock at an exercise price of $2.6875 per share expiring May 10,
2015. The Placement Agent Warrants are not covered by the Form
S-3.  The net proceeds to the Company from such offering, after
deducting the Placement Agent’s fees and expenses, the Company’s estimated
offering expenses, and excluding the proceeds, if any, from the exercise of the
warrants issued in the offering were approximately $4.6
million.
  20
  Warrants:
 
 The Company has issued common stock
purchase warrants from time to time to investors in private placements and
public offerings, and to certain vendors, underwriters, placement agents and
consultants of the Company. A total of18,027,028shares of common stock are reserved for
issuance upon exercise of outstanding warrants as ofJune 30,
2010at prices ranging
from$0.50 to $6.50and expiring throughApril
2017.
 
 During
the three months and six months ended June 30, 2010 the Company issued warrants
for services as follows ($ in thousands):
  Number of
      CommonStock
    Purchase
                
                
                Value of Common
      Stock
                
                
                Common Stock
      PurchaseWarrants
    Issued
                
                
                Purchase Warrants
      Issued
                
                
                Warrant Expense
      RecognizedThree
Months
                
                
                Six Months
                
                
                Three
Months
                
                
                Six Months
                
                
                Three
Months
                
                
                Six MonthsEnded
                
                
                Ended
                
                
                Ended
                
                
                Ended
                
                
                Ended
                
                
                Ended6/30/2010
                
                
                6/30/2010
                
                
                6/30/2010
                
                
                6/30/2010
                
                
                6/30/2010
                
                
                6/30/2010Warrants issued for investor
      relations services
                
                
                -
                
                
                
                200,000
                
                
                $
                -
                
                
                $
                242.7
                
                
                $
                65.7
                
                
                $
                192.1Warrants issued for consulting
      services
                
                
                50,000
                
                
                
                325,000
                
                
                $
                392.7
                
                
                $
                392.7
                
                
                $
                324.9
                
                
                $
                324.9Warrants issued for legal
      services
                
                
                25,000
                
                
                
                77,000
                
                
                $
                46.4
                
                
                $
                104.0
                
                
                $
                6.6
                
                
                $
                47.6
  On March 15, 2010, the Company and
RimAsia, an affiliate of the Company, made certain agreements with respect to
outstanding warrants.  RimAsia exercised its warrant to purchase
1,000,000 shares of the Company’s common stock, exercisable at a per share
exercise price of $1.75, which was issued to RimAsia in a private placement
completed by the Company in September 2008 (the “September 2008
Warrant”).  This exercise resulted in proceeds to the Company totaling
$1,750,000.  The condition for such exercise was that the Company would
modify certain terms of RimAsia’s warrant to purchase 4,000,000 shares of Common
Stock, issued to RimAsia in a private placement completed by the Company in
April 2009 (the “Series D Warrant”).  The Series D
Warrant was amended to provide for (i) a three (3) year extension of
the Termination Date from September 1, 2013 to September 1, 2016, and (ii) an
increase in the average closing price that triggers the Company’s redemption
option under the Series D Warrant from $3.50 to $5.00.  The change in
terms resulted in a charge to other expense totaling approximately
$188,000.
 
 Warrant activity is as
follows:
  Number
      of Shares
                
                
                Weighted
      Average Exercise Price
                
                
                Weighted
      Average Remaining Contractual Term (years)
                
                
                Aggregate
      Intrinsic ValueBalance
      at December 31, 2009
                
                
                19,838,802
                
                
                $
                3.00Granted
                
                
                1,276,417
                
                
                
                2.25Exercised
                
                
                (1,425,000
                )
                
                
                1.72Expired
                
                
                (1,663,191
                )
                
                
                6.35Cancelled
                
                
                -Balance
      at June 30, 2010
                
                
                18,027,028
                
                
                $
                2.73
                
                
                $
                4.2
                
                
                $
                968,247
  21
  AtJune 30, 2010the outstanding warrants by range
of exercise prices are as follows:
  Weighted
      AverageNumber
      Outstanding
                
                
                Remaining
                
                
                Number
      ExercisableExercise
      Price
                
                June 30,
    2010
                
                
                Contractual Life
      (years)
                
                
                June 30,
    2010$0.50 to
    $1.01
                
                
                699,000
                
                
                
                0.8
                
                
                
                678,841$1.01 to
    $1.99
                
                
                1,442,709
                
                
                
                1.7
                
                
                
                1,366,709$1.99 to
    $2.53
                
                
                13,277,512
                
                
                
                2.5
                
                
                
                13,152,512$2.53 to
    $5.99
                
                
                929,928
                
                
                
                3.2
                
                
                
                929,928$5.99 to
    $6.50
                
                
                1,677,879
                
                
                
                6.1
                
                
                
                1,677,87918,027,028
                
                
                
                2.7
                
                
                
                17,805,869
  Options:
 
 The
Company’s 2003 Equity Participation Plan (the “2003 Equity Plan”) permits the
grant of share options and shares to its employees, directors, consultants and
advisors for up to 2,500,000 shares of Common Stock as stock-based
compensation.  The 2009 Equity Compensation Plan (the “2009 Equity
Plan”) makes up to 13,750,000 shares of Common Stock of the Company available
for issuance to employees, consultants, advisors and directors of the Company
and its subsidiaries pursuant to incentive or non-statutory stock options,
restricted and unrestricted stock awards and stock appreciation
rights.
 
 All stock
options under the 2003 Equity Plan and the 2009 Equity Plan are generally
granted at the fair market value of the Common Stock at the grant
date.  Stock options vest either on the date of grant, ratably over a
period determined at time of grant, or upon the accomplishment of specified
business milestones, and generally expire 10 years from the grant
date.
 
 The 2009
Equity Plan was originally adopted by the shareholders of the Company on May 8,
2009.  On October 29, 2009, the shareholders of the Company approved
an amendment to the 2009 Equity Plan to increase the number of shares of common
stock available for issuance thereunder from 3,800,000 to
9,750,000.  At the 2010 Annual Meeting of Stockholders of the Company
held on June 2, 2010, the shareholders approved an amendment to increase this
number to 13,750,000.
 
 The 2003
Equity Plan and the 2009 Equity Plan are sometimes collectively referred to as
the Company’s “U.S. Equity Plan.”
 
 The
Company’s 2009 Non-U.S. Based Equity Compensation Plan (“Non-U.S. Plan”) makes
up to 8,700,000 shares of Common Stock of the Company available for
issuance.  Persons eligible to receive restricted and unrestricted
stock awards, warrants (option-like equity grants), stock appreciation rights or
other awards under the Non-U.S. Plan are those service providers to the Company
and its subsidiaries and affiliates providing services outside of the United
States, including employees and consultants of the Company and its subsidiaries
and affiliates, who, in the opinion of the Compensation Committee, are in a
position to contribute to the Company’s success.   Warrants vest
either on the date of grant, ratably over a period determined at time of grant,
or upon the accomplishment of specified business milestones, and generally
expire 10 years from the grant date.
 
 The
Non-U.S. Plan was originally adopted by the shareholders of the Company on
October 29, 2009. At the 2010 Annual Meeting of Stockholders of the Company held
on June 2, 2010, the shareholders approved an amendment to increase the number
of shares of common stock authorized for issuance thereunder from 4,700,000 to
8,700,000.
  The Company’s results include
share-based compensation expense of $1,843,721and $1,338,617for thethreemonths ended June 30, 2010 and 2009,
respectively and $3,529,355and $1,398,387for
thesixmonth periods
endedJune 30, 2010and 2009,
respectively.  Options vesting on the accomplishment of business
milestones will not be recognized for compensation purposes until such
milestones are deemed probable of accomplishment. AtJune 30,
2010there were options to
purchase1,706,075shares outstanding that will vest upon the accomplishment of business milestones
and will be accounted for as an operating expense when such business
milestones are deemed probable of accomplishment.
 
 The weighted average estimated fair
value of stock options granted in thethree and sixmonths endedJune 30,
2010was $1.85and$1.83, respectively. The fair value of
options at the date of grant was estimated using the Black-Scholes option
pricing model. The expected volatility is based upon historical volatility of
the Company’s stock and other contributing factors. The expected term is based
upon observation of actual time elapsed between date of grant and exercise of
options for all employees.
  22
  The range of assumptions made in
calculating the fair values of options are as follows (the same assumptions were
used for warrants, the term for the warrant is based on the life of the
warrant):
  Three Months
      Ended
                
                Six Months
      EndedJune 30,
    2010
                
                June 30,
    2009
                
                June 30,
    2010
                
                June 30,
    2009Expected term (in
      years)
                
                5 to 10
                
                10
                
                5 to 10
                
                10Expected
      volatility
                
                95% - 100%
                
                195% to
217%
                
                95% - 124%
                
                195% to
  217%Expected dividend
      yield
                
                0%
                
                0%
                
                0%
                
                0%Risk-free interest
      rate
                
                1.78% -
    3.58%
                
                3.35% to
    3.81%
                
                1.78% -
    3.80%
                
                3.35% to
    3.81%
  Stock option activity under the U.S.
Equity Plan is as follows:
  Number of
      Shares
                
                
                Weighted Average Exercise
      Price
                
                
                Weighted Average Remaining
      Contractual Term
                
                
                Average Intrinsic
      ValueBalance at December 31,
      2009
                
                
                8,340,574
                
                
                $
                1.93Granted
                
                
                790,000
                
                
                $
                1.98Exercised
                
                
                (90,000
                )
                
                $
                1.56Expired
                
                
                -Cancelled
                
                
                (98,360
                )
                
                $
                1.61Balance at June 30,
      2010
                
                
                8,942,214
                
                
                $
                1.89
                
                
                
                8.6
                
                
                $
                600,000Vested and Exercisable at June 30,
      2010
                
                
                4,549,764
                
                
                
                
                
                
                
                
                
                
                $
                310,345
  Number
      Outstanding
                
                Weighted
      Average
                
                Number
      ExercisableJune 30,
    2010
                
                Remaining Contractual
      Term
                
                June 30,
    2010Exercise
    Price$  0.71 to
      $  1.89
                
                3,861,000
                
                9.02
                
                1,855,000$  1.89 to
      $  1.96
                
                3,123,664
                
                7.65
                
                2,313,880$  1.96 to
      $  4.96
                
                1,906,200
                
                9.41
                
                329,534$  4.96 to
      $7.01
                
                27,250
                
                5.09
                
                27,250$7.01 to
    $15.00
                
                24,100
                
                4.45
                
                24,1008,942,214
                
                
                
                4,549,764
  Stock option activity under the Non U.S.
Equity Plan is as follows:
  Number of
      Shares
                
                
                Weighted Average Exercise
      Price
                
                
                Weighted Average Remaining
      Contractual Term
                
                
                Average Intrinsic
      ValueBalance at December 31,
      2009
                
                
                1,650,000
                
                
                $
                2.04Granted
                
                
                1,250,000
                
                
                $
                2.26Exercised
                
                
                -Expired
                
                
                -Cancelled
                
                
                -Balance at June 30,
      2010
                
                
                2,900,000
                
                
                $
                2.13
                
                
                
                9.6
                
                
                $
                -Vested and Exercisable at June 30,
      2010
                
                
                300,000
                
                
                
                
                
                
                
                
                
                
                $
                -
  23
  Number
      Outstanding
                
                Weighted
      Average
                
                Number
      ExercisableJune 30,
    2010
                
                Remaining Contractual
      Term
                
                June 30,
    2010Exercise
    Price$  2.04 to
      $  2.10
                
                1,650,000
                
                9.33
                
                150,000$  2.10 to
      $  2.17
                
                650,000
                
                9.95
                
                150,000$  2.17 to
      $  2.36
                
                600,000
                
                9.97
                
                -2,900,000
                
                
                
                300,000
  The total fair value of shares vested
during thethree and sixmonths endedJune 30,
2010was
$1,051,225and1,451,840,
respectively.
 
 The number of remaining shares
authorized to be issued under the various equity plans are as
follows:
  US Equity
    Plan
                
                
                Non US Equity
      PlanShares Authorized for Issuance
      under 2003 Equity Plan
                
                
                2,500,000
                
                
                
                -Shares Authorized for Issuance
      under 2009 Equity Plan
                
                
                13,750,000
                
                
                
                -Shares Authorized for Issuance
      under Non US Equity Plan
                
                
                -
                
                
                
                8,700,00016,250,000
                
                
                
                8,700,000Outstanding Options - US Equity
      Plan
                
                
                (8,942,214
                )
                
                
                -Outstanding Options - Non US
      Equity Plan
                
                
                -
                
                
                
                (2,900,000
                )Common shares issued under the
      option plans
                
                
                (2,224,737
                )
                
                
                (875,000
                )Total common shares remaining to
      be issued under the Option Plans
                
                
                5,083,049
                
                
                
                4,925,000
 
 Options are usually granted at an
exercise price at least equal to the fair value of the Common Stock at the grant
date and may be granted to employees, directors, consultants and advisors of the
Company and its subsidiaries.  As ofJune 30, 2010, there was approximately
$9,835,533of total
unrecognized compensation costs related to unvested stock option awards of which
$6,310,861 of unrecognized
compensation expense is related to stock options that vest over a weighted
average life of1.2years. The balance of unrecognized compensation costs, $3,524,673, is related to stock options that vest
based on the accomplishment of business milestones as to which expense is
generally recognized when such milestone is probable.
 
 Note 10 – Income
Taxes
 The Tax Reform Act of 1986 enacted a
complex set of rules limiting the utilization of net operating loss
carryforwards to offset future taxable income following a corporate ownership
change. The Company’s ability to utilize its NOL carryforwards is limited
following a change in ownership in excess of fifty percentage points during any
three-year period.
  Since the year 2000, the Company has had
several changes in ownership which has resulted in a limitation on the Company’s
ability to apply net operating losses to future taxable
income.  Approximately $7,000,000 of net operating losses had expired
due to these limitations. At December 31, 2009, the Company had net operating
loss carryforwards of approximately $26,450,000 applicable to future Federal
income taxes. The tax loss carryforwards are subject to annual limitations and
expire at various dates through 2029. The Company has recorded a full valuation
allowance against its net deferred tax asset because of the uncertainty that the
utilization of the net operating loss will be
realized.
  The Company determined that a book/tax
basis difference exists in recording the fair value of the intangible assets
acquired in connection with the Merger.  Increasing the value of the
acquired asset to fair value, while deductible for book purposes, are not
deductible for local Chinese tax purposes but require recognition of the impact
such non-deductibility will have on future tax expense.  Specifically,
the Company established as of the Merger date deferred tax liabilities of
approximately $4,720,800 for such book/tax basis difference. This deferred tax
liability will be recognized ratably as amortization of certain intangible
assets occurs.
  Note 11 – Segment
Information
 Historically, the Company’s operations
have been conducted in only one geographical segment and since March 31, 2007
the Company had realized revenue only from one industry segment, the banking of
adult autologous stem cells. In June 2009, the Company established NeoStem
(China), Inc. (“NeoStem China” or the “WFOE”) as a wholly foreign owned
subsidiary of the Company. The WFOE is domiciled in Qingdao and under its scope
of business approved by the Chinese regulatory authorities, the WFOE may engage
in the research & development, transfer and technological consultation
service of bio-technology, regenerative medical technology and anti-aging
technology (excluding the development or application of human stem cell, gene
diagnosis and treatment technologies); consultation of economic information;
import, export and wholesaling of machinery and equipments (the import and
export do not involve the goods specifically stipulated in/by state-operated
trade, import & export quota license, export quota bidding, export permit,
etc.). In furtherance of complying with PRC’s foreign investment prohibition on
stem cell research and development, clinical trials and related activities, the
Company conducts its current business in the PRC via two domestic variable
interest entities. On October 30, 2009, in connection with the Merger, the
Company acquired CBH’s 51% ownership interest in Erye which specializes in
research and development, production and sales of pharmaceutical products, as
well as chemicals used in pharmaceutical products.  As a result the Company
now operates in the United States and China.
  24
  The Company’s segment data is as follows
(in thousands):
  Three Months Ended June
      30,
                
                
                Six Months Ended June
      30,2010
                
                
                2009
                
                
                2010
                
                
                2009United
    StatesStem Cell
      Revenues
                
                $
                21.7
                
                
                $
                14.0
                
                
                $
                66.4
                
                
                $
                58.6Other
    Revenues
                
                
                16.1
                
                
                
                17.6
                
                
                
                30.1
                
                
                
                18.1ChinaPrescription drugs and
      intermediary pharmaceutical products
                
                
                19,351.3
                
                
                
                -
                
                
                
                35,122.5
                
                
                
                -Other
    Revenues
                
                
                18.4
                
                
                
                -
                
                
                
                21.7
                
                
                
                -$
                19,407.5
                
                
                $
                31.6
                
                
                $
                35,240.7
                
                
                $
                76.7Income/(loss) from
      operations:United
    States
                
                $
                (5,429.7
                )
                
                $
                (3,694.1
                )
                
                $
                (9,888.3
                )
                
                $
                (5,417.9
                )China
                
                
                1,926.8
                
                
                
                (1,005.3
                )
                
                
                3,777.1
                
                
                
                (1,138.4
                )$
                (3,502.9
                )
                
                $
                (4,699.4
                )
                
                $
                (6,111.2
                )
                
                $
                (6,556.3
                )Total
Assets
                
                June 30,
    2010
                
                
                
                
                
                
                December 31,
      2009United
    States
                
                
                10,775.9
                
                
                
                
                
                
                
                6,930.2China
                
                
                113,071.7
                
                
                
                
                
                
                
                101,963.7$
                123,847.6
                
                
                
                
                
                
                $
                108,893.9
  Note 12 – Related Party
Transactions
 On April 30, 2009, the Company entered
into a License and Referral Agreement with Promethean Corporation (“Promethean”)
through its subsidiary Ceres Living, Inc. (“Ceres”) to use certain Company marks
and publications in connection with certain sales and marketing activities
relating to its nutritional supplement known as AIO Premium Cellular (the
“Product”); and in connection with the license, Ceres will pay to the Company or
the Stem for Life Foundation specified fees  for  each unit
of the Product sold; and Ceres shall engage in a referral service with respect
to the Company’s adult stem cell collection and storage activities. Ceres will
receive a specified fee from the Company for each client referred who completes
and pays for a stem cell collection. The term of the agreement is three years
with each party having the right to renew annually, thereafter. The Stem for
Life Foundation is a 501(c)(3) charitable organization of which the Company’s
CEO, and Vice President and General Counsel, are directors and the President and
Secretary, respectively, and of which the Company participated in the
founding.  The CEO of Promethean is in an exclusive relationship with
the CEO of the Company. The Company has earned $4,865 and $8,750 in royalties in
connection with this agreement during the three and six months ended June 30,
2010, respectively.  The royalty payments were not material in
2009.  Additionally Promethean has been responsible for referral of
certain clients for our stem cell collection business and receives a commission
of 10% for such referrals.Through June 30, 2010 these
commissions were not significant.
 
 AtJune 30, 2010, Erye owed EET, 49% shareholder of
Erye, $7,855,200.  Included in the amount owed
to EET are:
 ·
              Dividends paid and loaned back to
      Erye amounting to $7,734,200 and accrued interest of
      $349,400, the
      interest rate on this loan is5.31%.  Erye received an
      interest payment of approximately $192,700in February
      2010.
 
 ·
              Advances to EET of
      $617,600;
      and
 
 ·
              A non interest bearing loan from
      EET of $389,100due
      2011.
 
 On May
11, 2010, the Company entered into a one-year consulting agreement with RimAsia
whereby RimAsia will act as an advisor to the Company in connection with the
Company exploring and pursuing various pharmaceutical and biotech ventures in
China.  RimAsia does not receive compensation under this
agreement.  In connection with the consulting agreement, RimAsia has
entered into a confidentiality agreement, whereby RimAsia agrees that neither it
nor its representatives will disclose NeoStem material and shall only use such
material for the purpose of providing the services under the consulting
agreement.  NeoStem retains all ownership rights in such material as
well as material prepared for it pursuant to the consulting
agreement.
  25
  Note 13 – Commitments and
Contingencies
 On May 26, 2006, the Company entered
into an employment agreement with Dr. Robin L. Smith, pursuant to which
agreement, as amended to date, Dr. Smith serves as the Chief Executive Officer
of the Company.
 
 Effective as of September 27, 2009, Dr.
Smith’s annual base salary is $332,750, increased by 10% annually on that
date.  On July 29, 2009, the Company amended the terms of its
employment agreement with Dr. Smith by means of a letter agreement to extend the
term of Dr. Smith’s employment to December 31, 2011 and subject to the
consummation of the Merger with CBH (which Merger was consummated on October 30,
2009), award Dr. Smith a $275,000 cash bonus for 2009 and comparable minimum
annual bonuses for 2010 and 2011.  The Company maintains key-man life
insurance on Dr. Smith in the amount of $3,000,000.  As of October 29,
2009, the Compensation Committee approved the reimbursement to Dr. Smith of
premiums, up to $4,000 annually, for disability insurance covering Dr.
Smith.  The Company has also agreed to pay membership and annual fees
for a club in New York of Dr. Smith’s choice for business entertaining and
meetings, and a car allowance equal to $1,000 per month.
 
 Per Dr. Smith’s January 26, 2007 letter
agreement with the Company, upon termination of Dr. Smith’s employment by the
Company without cause or by Dr. Smith with good reason, the Company shall pay to
Dr. Smith her base salary at the time of termination for the two year period
following such termination.   Dr. Smith’s September 27, 2007
letter agreement provides that such payment of severance can be made instead in
12 equal monthly installments beginning the date of termination.  In
addition, per Dr. Smith’s May 26, 2006 employment agreement, upon termination of
Dr. Smith’s employment by the Company without cause or by Dr. Smith for good
reason, Dr. Smith is entitled to: (i) a pro-rata bonus based on the annual bonus
received for the prior year; (ii) COBRA payments for a one year period; and
(iii) have all vested, options as well as all options that would have vested
during the 12-month period following the date of termination, become fully
vested and remain exercisable for a maximum of 48 months (but in no event longer
than the original term of exercise.) Upon termination of Dr. Smith’s employment
by the Company for cause or by Dr. Smith without good reason, Dr. Smith is
entitled to: (i) the payment of all amounts due for services rendered under the
agreement up until the termination date; and (ii) have all vested options remain
exercisable for a period of ninety days (all stock options which have not vested
shall be forfeited.)  Upon termination for death or disability, Dr.
Smith (or her estate) is entitled to: (i) the payment of all amounts due for
services rendered under the agreement until the termination date; (ii) family
COBRA payments for the applicable term; and (iii) have all vested options,
remain exercisable for a maximum of 48 months (but in no event longer than the
original term of exercise).
 
 Per Dr. Smith’s May 26, 2006 employment
agreement, upon a change in control of the Company, options held by Dr. Smith
shall be governed by the terms of applicable agreements and equity compensation
plans, but in any event at least 75% of Dr. Smith’s then unvested options shall
become immediately vested and exercisable upon a change in control. Further, in
the event Dr. Smith voluntarily terminates her employment without good reason
following a change in control, Dr. Smith shall be entitled to: (i) the payment
of base salary for one year; (ii) a pro-rata bonus based on the annual bonus
received for the prior year; (iii) COBRA payments for a one year period; and
(iv) have all vested options, as well as all options which would have vested
during the 12-month period following the date of termination, become fully
vested and remain exercisable for a maximum of 48 months (but in no event longer
than the original term of exercise).
 
 On January 26, 2007, the Company entered
into an employment agreement with Catherine M. Vaczy pursuant to which
agreement, as amended to date, Ms. Vaczy continues to serve as the Company’s
Vice President and General Counsel.
 
 Ms. Vaczy’s January 26, 2007 employment
agreement, as amended on January 9, 2008 and August 29, 2008, or the Original
Agreement, expired by its terms on December 31, 2008. However, effective July 8,
2009, the Company entered into another letter agreement, or the Extension, with
Ms. Vaczy pursuant to which the Original Agreement was extended, subject to
certain different and additional terms. The Extension provides that Ms. Vaczy’s
base salary during the one-year term will be $182,500. The Extension
additionally provides for (i) a 25,000 share stock award upon execution under
the 2009 Plan where the Company also pays the associated payroll taxes; and (ii)
a $5,000 cash bonus upon each of two milestone objectives established by the
Board of Directors (one of which was met in the fourth quarter of 2009 and the
other in the first quarter of 2010). Pursuant to the Original Agreement, as
extended and otherwise amended to date, Ms. Vaczy was also entitled to payment
of certain perquisites and/or reimbursement of certain expenses incurred by her
in connection with the performance of her duties and obligations under the
letter agreement (including a car allowance equal to $1,000 per month), and to
participate in any incentive and employee benefit plans or programs which may be
offered by the Company and in all other plans in which the Company executives
participate.
 
 As of October 29, 2009, the Compensation
Committee of the Board (i) awarded Ms. Vaczy a $50,000 cash bonus, 50% of which
was payable currently and the remaining 50% payable upon the achievement of a
business milestone (which was achieved in February 2010), (ii) increased Ms.
Vaczy’s salary from $182,500 to $191,000 effective as of November 1, 2009, and
(iii) approved the payment of dues to a private club of Ms. Vaczy’s choosing for
business entertaining and meetings (not to exceed $6,000
annually).
  26
  In the event Ms. Vaczy’s employment is
terminated prior to the end of the term, for any reason, earned but unpaid cash
compensation and unreimbursed expenses due as of the date of such termination
would be payable in full. In addition, in the event Ms. Vaczy’s employment is
terminated prior to the end of the term for any reason other than by the Company
with cause or Ms. Vaczy without good reason, Ms. Vaczy or her executor of her
last will or the duly authorized administrator of her estate, as applicable,
would be entitled to receive certain specified severance payments, paid in
accordance with the Company’s standard payroll practices for
executives.  In no event would such payments exceed the remaining
salary payments in the term.  Any severance payments set forth in the
Original Agreement to which Ms. Vaczy may become entitled shall be based on Ms.
Vaczy’s then salary for a three month and not an annual
period.   In the event her employment is terminated prior to the
end of the term by the Company without cause or by Ms. Vaczy for good reason,
all options granted by the Company will immediately vest and become exercisable
in accordance with their terms.  Any options provided for in the
Extension, as well as other options granted or to be granted to Ms. Vaczy, shall
remain exercisable despite any termination of employment for a period of not
less than two years from the date of termination of
employment.
 
 See Note
14 – Subsequent Events, for information on an employment agreement extension
entered into with Ms. Vaczy in July 2010 providing for certain different and
additional employment terms.
 
 On October 29, 2009, the Compensation
Committee adopted that certain Additional Compensation Plan providing that
contingent cash bonuses, in the total amount of $200,806, would be payable upon
the occurrence of a “Cash Flow Event” which occurred in the first quarter of
2010.  Of such amounts, two members of the Company’s Board of
Directors, one former member of the Company’s Board of Directors, the Company’s
CEO, CFO and General Counsel participated in a total of $134,232 of such
amount.
 
 Pursuant to the terms of the Director
Compensation Plan adopted on November 4, 2009, as amended, each non-employee
director of the Company, including directors who are employees of partially
owned joint ventures, are entitled to quarterly cash compensation equal to
$15,000, payable in arrears.  Based on the current Board structure,
this will equal approximately $360,000 annually.
 
 As of October 2, 2009, the Company
entered into indemnification agreements with its Chief Executive Officer, Chief
Financial Officer, General Counsel, certain other employees and each of its
directors pursuant to which the Company has agreed to indemnify such party to
the full extent permitted by law, subject to certain exceptions, if such party
becomes subject to an action because such party is the Company’s director,
officer, employee, agent or fiduciary.
 
 In November 2007, the Company entered
into an acquisition agreement with UTEK Corporation ("UTEK") and Stem Cell
Technologies, Inc., a wholly owned subsidiary of UTEK ("SCTI"), pursuant to
which the Company acquired all the issued and outstanding common stock of SCTI
in a stock-for-stock exchange. SCTI contains an exclusive, worldwide license to
a technology developed by researchers at the University of Louisville to
identify and isolate rare stem cells from adult human bone marrow, called very
small embryonic like stem cells. Concurrent with the SCTI acquisition, NeoStem
entered into a sponsored research agreement (“SRA”) with the University of
Louisville under which NeoStem has been supporting further research in the
laboratory of Mariusz Ratajczak, M.D., Ph.D. a co-inventor of the VSELTM
technology and head of the Stem Cell Biology Program at the James Brown Cancer
Center at the University of Louisville. The SRA, which has been periodically
amended, called for payments in 2008 of $50,000, 2009 of $65,337, and 2010 of
$86,068, of which $43,034 has been paid.  An additional aggregate of
$95,128 is payable in 2011 until December 31, 2011, the end of the
term.
 
 Under a License Agreement entered into
with the University of Louisville Research Foundation (“ULRF”) in November 2007,
SCTI agreed to engage in a diligent program to develop the VSEL technology.
Certain license fees and royalties are to be paid to ULRF from SCTI, and SCTI is
responsible for all payments for patent filings and related applications.
Portions of the license may be converted to a non-exclusive license if SCTI does
not diligently develop the VSELTM technology or terminated entirely if SCTI
chooses to not pay for the filing and maintenance of any patents thereunder.
Under the License Agreement, which has an initial term of 20 years, the Company
has paid to date approximately $117,000 consisting of various up-front fees,
including $22,000 in connection with its May 2010 amendment, and is required to
pay under the license certain other future fees including: (i) a specified
non-refundable annual license maintenance fee upon issuance of the licensed
patent in the United States; (ii) a specified royalty on net sales; (iii)
specified milestone payments; and (iv) specified payments in the event of
sublicensing.  The License Agreement also contains certain provisions
relating to "stacking," permitting SCTI to pay royalties to ULRF at a reduced
rate in the event it is required to also pay royalties to third parties
exceeding a specified threshold for other technology in furtherance of the
exercise of its patent rights or the manufacture of products using the VSEL
technology.
 
 As of December 31, 2009, the Company,
NeoStem (China) , Inc., its subsidiary and Progenitor Cell Therapy, LLC, a
Delaware limited liability company ("PCT”), entered into an Agreement (the
“Agreement”) whereby NeoStem and NeoStem China engaged PCT to perform the
services necessary to construct in Beijing, China a facility consisting of a
clean room for adult stem cell clinical trial processing and other stem cell
collections which will have the processing capacity on an annual basis
sufficient for at least 10,000 samples, research and development laboratory
space, collection and stem cell storage area and offices, together with the
furnishings and equipment and (2) the installation of quality control systems
consisting of materials management, equipment maintenance and calibration,
environmental monitoring and compliance and adult stem cell processing and
preservation which comply with cGMP standards and  regulatory
standards that would be applicable in the United States under GTP standards, as
well as all regulatory requirement applicable to the program under the laws of
the People's Republic of China.  The aggregate cost of the program,
including the phase 1 equipment purchases, is expected to be approximately $3
million.  The project is anticipated to take until the end of 2010 to
complete.  PCT has agreed to provide at least 90 days of support
services to NeoStem for an additional fee after completion of the project, which
is renewable at NeoStem's request for an additional 90 days.
  27
  In connection with the issuance to
investors and service providers of many of the shares of the Company’s common
stock and warrants to purchase common stock previously disclosed and described
herein, the Company granted the holders registration rights providing for the
registration of such shares of common stock and shares of common stock
underlying warrants on a registration statement to be filed with the Securities
and Exchange Commission so as to permit the resale of those
shares.  Certain of the registration rights agreements provided for
penalties for failure to file or failure to obtain an effective registration
statement.  With respect to satisfying its obligations to the holders
of these registration rights, the Company is in various
positions.  The Company filed a registration statement as required for
some of the holders, but to date, the Company has not had such registration
statement declared effective.  As to some holders, the Company has not
yet satisfied its obligation to file.  Certain holders with
outstanding registration rights have waived their registration
rights.  No holder has yet asserted any claim against the Company with
respect to a failure to satisfy any registration obligations.  Were
someone to assert a claim against the Company for breach of registration
obligations, the Company believes it has several defenses that would result in
relieving it from some or any liability, although no assurances can be
given.  The Company also notes that damage claims may be limited, as
(i) all shares of Common Stock as to which registration rights attached are
currently salable under Rule 144 of the Securities Act and (ii) during much of
the relevant periods the warrants with registration rights generally have been
out of the money.  Accordingly, were holders to assert claims against
the Company based on breach of the Company’s obligation to register, the Company
believes that the Company’s maximum exposure from non-related parties would not
be material.
 
 Xiangbei Welman Pharmaceutical Co.,
Ltd. v Suzhou Erye Pharmaceutical Co., Ltd. and Hunan Weichu Pharmacy Co.,
Ltd. involves a patent infringement dispute with respect to a particular
antibiotics complex manufactured by Erye (the “Product”).  The
Changsha Intermediate People’s Court in Hunan Province, PRC in the foregoing
case rendered a judgment on May 13, 2010 against Erye as follows: (i) awarding
plaintiff Xiangbei Welman damages and costs of approximately  5 million RMB
(approximately $750,000) against Erye which was fully accrued for at June 30,
2010; and (ii) enjoining Erye from manufacturing, marketing and selling the
Product.  The Product represented less than 2% of Erye’s sales in
2009.  Erye has appealed the court judgment, and is also engaged in
settlement negotiations.
 
 A related
but separate lawsuit entitled Xiangbei Welman Pharmaceutical Co.,
Ltd. v Suzhou Erye Pharmaceutical Co., Ltd. and Hunan Weichu Pharmacy Co.,
Ltd., involves a copyright infringement dispute with respect to package
inserts of the same Product.  The Changsha Intermediate People’s Court
in Hunan Province, PRC rendered a decision on August 3, 2010 against Erye,
dismissing its appeal from a lower court’s judgment made by the People’s Court
of Yuelu District, Changsha City, which (i) enjoins Erye from copying and using
the package inserts for the Product and selling the drugs with the aforesaid
package inserts; and (ii) awarding Welman economic losses of approximately
50,000 RMB (approximately $7,500) against Erye.  Erye has decided to
appeal the court judgment, and is also engaged in settlement
negotiations.
  Note 14 – Subsequent
Events
 The
following are the subsequent events that management believes materially effect
the financial position or results of operations or are otherwise informative to
the reader of these financial statements.
 
 On July
7, 2010, the Company entered into a consulting agreement pursuant to which a
consultant was retained to assist the Company in providing sponsorship of the
Company’s securities in the public markets and to perform investor relations
services for a three month term.  In consideration for providing
services under this agreement, the Company issued to the consultant 150,000
shares of restricted common stock with a fair value of $262,500, to vest as to
one-third on each of the first, second and third one-month anniversaries of the
effective date of the agreement.
 
 On July
7, 2010, pursuant to a letter agreement (the “Employment Agreement Extension”)
entered into with Catherine M. Vaczy, Esq., the Company’s Vice President and
General Counsel, the Company extended Ms. Vaczy’s employment agreement dated
January 26, 2007, as amended on January 9, 2008 and August 29, 2008 and
reinstated and extended on July 8, 2009 for a one year term (as so amended and
extended, the “Original Employment Agreement”).  The Employment
Agreement Extension was effective as of July 7, 2010 (the “Effective Date”) and
continues through December 31, 2011 (as extended, the “Term”).  The
Employment Agreement Extension provides that during the Term, Ms. Vaczy shall
receive (i) a base salary of $211,000 per annum which will be increased by ten
percent (10%) on the one year anniversary of the Effective Date; (ii) a bonus of
$50,000, half of which is payable upon the Effective Date and half of which is
payable upon achievement of a business milestone; (iii) a minimum bonus of
$60,000 during the second year of the Term; (iv) an  option (the
“Option”) on the Effective Date under the Company’s 2009 Plan to purchase
350,000 shares of the Company’s common stock, which shall vest and become
exercisable as to 100,000 shares on the one year anniversary of the Effective
Date, 50,000 shares on December 31, 2011, and as to the remaining 200,000 shares
upon the achievement of specified business milestones, the per share exercise
price of the Option equal to the closing price of the common stock on the
Effective Date and the Option subject to all the terms and conditions of the
2009 Plan; (v) the costs of personal stem cell collection; and (vi) business
club dues not to exceed $5,000 annually.  Except as set forth in the
Employment Agreement Extension, the terms of the Original Employment Agreement
remain unchanged.
  28
  On July
7, 2010, the vesting of options to purchase an aggregate of 500,000 shares of
common stock at $2.04 per share, previously granted under the 2009 Plan to Robin
L. Smith, the Company’s Chief Executive Officer, effective October 29, 2009,
which were originally scheduled to vest as to 250,000 shares on July 8, 2011 and
as to 250,000 shares upon the achievement of a business milestone, was
accelerated to July 7, 2010 as authorized by the Compensation Committee of the
Board of Directors.
 
 On July
27, 2010, consistent with the Company’s previously disclosed intention to
provide support for its charitable foundation, The Stem for Life Foundation (the
“Foundation”), which promotes public awareness, funds research and development
and subsidizes stem cell collection and storage programs, the Company issued to
the Foundation of 150,000 shares of restricted common stock with a fair value of
$298,500.  The issuance of such securities was subject to the approval
of the Audit Committee, the Compensation Committee and the NYSE
Amex.  On July 2, 2010, the Company also contributed $75,000 to Stem
for Life.
 
 In July
2010, the Company was awarded a $700,000 contract from the U.S. Army Medical
Research and Materiel Command, Telemedicine and Advanced Technology Research
Center. This contract is for the purpose of evaluating the use of topically
applied bone marrow-derived adult mesenchymal stem cells for rapid wound
healing. The Company previously announced that this funding was included in the
Department of Defense FY09 Appropriations Bill and will begin receiving funds to
initiate the program in 2010.
  ITEM 2. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties.  Any statements not of current or historical fact may
be considered forward-looking statements.  Our actual results could
differ materially from those anticipated in these forward-looking statements as
a result of various factors, including those discussed under the heading
“Cautionary Note Regarding Forward-Looking Statements” at the end of this item
and under “Risk Factors” and elsewhere in this report.  The following
discussion should be read in conjunction with our consolidated financial
statements and related notes thereto included elsewhere in this report and in
our Annual Report on Form 10-K for the year ended December 31,
2009.
 
 The Merger
 
 As previously reported, on November 2,
2008 we entered into the Merger Agreement with CBH. On October 30, 2009, the
Merger was consummated, the effect of which was our acquisition of CBH’s 51%
ownership interest in Erye. In connection with the Merger we established a
wholly owned subsidiary through which we acquired our interest in
Erye.The results of operations for Erye are included in our
consolidated results of operations beginning on October 30,
2009.  Accordingly the year over year comparisons reflect NeoStem as a
stand-alone entity for 2009 and the combined results for Erye and NeoStem
for 2010.
  Erye was founded more than 50 years ago
and represents an established, vertically-integrated pharmaceutical business,
focused primarily on antibiotics. Suzhou Erye Economy and Trading Co. Ltd., or
EET, owns the remaining 49% ownership interest in Erye. We and EET have
negotiated a revised joint venture agreement or the Joint Venture Agreement and
will govern our ownership of Erye.
 
 Pursuant to the terms and conditions of
the Joint Venture Agreement, dividend distributions to EET and Merger Sub will
be made in proportion to their respective ownership interests in Erye; provided,
however, that for the three-year period commencing on the first day of the first
fiscal quarter after the Joint Venture Agreement becomes effective distributions
will be made as follows: (i) the 49% of undistributed profits (after tax) of the
joint venture due EET will be distributed to EET and lent back to Erye to help
finance costs in connection with their construction of and relocation to a new
facility; and (ii) of the net profit (after tax) of the joint venture due Merger
Sub, 45% will be provided to Erye as part of the new facility construction fund
and will be characterized as paid-in capital for Merger Sub’s 51% interest in
Erye, and 6% will be distributed to Merger Sub directly.As ofJune 30,
2010distributions totaling
approximately $7,201,600had been deferred and EET has received and
lent back approximately $7,734,300.
  29
  The Overview
 
 In 2009, through our expansion efforts
within China and with the acquisition of a controlling interest in Suzhou Erye
Pharmaceuticals Ltd., or Erye, we 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. 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.
 
 •
              U.S. adult stem cells — We will
      continue to focus on growing our stem cell collection, processing and
      storage business and expanding our research and development activities for
      diagnostic and therapeutic
applications.
  •
              China adult stem cells — We are in
      the process of launching several stem cell-focused initiatives which
      include therapeutic applications, as well as related collection,
      processing and storage.
  •
              China pharmaceuticals — Our
      ownership interest in Erye, a leading antibiotics producer in China,
      positions us to take advantage of China’s growth in healthcare spending
      through Erye’s existing pharmaceutical product portfolio, as well as from
      products we may develop or
license.
 
 Results of
Operations
 
 Three
and SixMonths
EndedJune 30, 2010Compared to theThree
and SixMonthsEndedJune 30, 2009
 
 Revenue
 
 Three
Months and Six Months Ended June 30, 2010 and June 30, 2009
 
 For thethreemonths endedJune 30, 2010, total revenues were $19,407,500
compared to $31,600  for thethreemonths endedJune 30, 2009. Revenues for
thethreemonths
endedJune 30, 2010were comprised of $19,351,300 of
pharmaceutical product sales and $56,200 related to stem cell collections,
license fees, royalties and other revenue. The pharmaceutical product sales
represent sales generated by Erye.  The stem cell revenues generated
in thethreemonths
endedJune 30, 2010and 2009 were derived from a
combination of revenues from the collection of autologous adult stem cells and
license fees collected from collection centers in our collection center network.
For thethreemonths
endedJune 30, 2010, we
earned $21,700 from the collection and storage of autologous adult stem cells,
and $16,100 of license fees, and $18,400 of otherrevenues. For thethreemonths endedJune 30, 2009, we earned $14,000 from the collection
and storage of autologous adult stem cells and $17,600 from license fees. The
increase in stem cell collection and storage revenue in 2010 compared to 2009
was due primarily to our efforts on recruiting clients into our network stem
cell collection centers. Cost of Sales for thethreemonths endedJune 30,
2010is comprised of Cost of
Goods sold of $12,894,900  related to the sale of our pharmaceutical
products, and $16,900 of direct costs related to the cost of collecting
autologous stem cells from clients.
  For thesixmonths endedJune 30, 2010, total revenues were
$35,240,702 compared to $76,700 for
thesixmonths endedJune 30, 2009. Revenues for
thesixmonths
endedJune 30, 2010were comprised of $35,122,500 of
pharmaceutical product sales and $118,200 related to stem cell collections,
license fees, royalties and other revenue. The pharmaceutical product sales
represent sales generated by Erye.  The stem cell revenues generated
in thesixmonths
endedJune 30, 2010and 2009 were derived from a
combination of revenues from the collection of autologous adult stem cells and
license fees collected from collection centers in our collection center network.
For thesixmonths
endedJune 30, 2010, we
earned $66,400 from the collection and storage of autologous adult stem cells,
$30,100 of license fees and $21,700 of otherrevenues. For thesixmonths endedJune 30, 2009, we earned $58,600 from the collection
and storage of autologous adult stem cells and $18,100 from license fees. The
increase in stem cell collection and storage revenue in 2010 compared to 2009
was due primarily to our efforts on recruiting clients into the existing network
in the Northeast and Southern California. Cost of Sales for
thesixmonths
endedJune 30, 2010is comprised of Cost of Goods sold
of $23,721,200 related to the sale of our pharmaceutical products, and $42,200
of direct costs related to the cost of collecting autologous stem cells from
clients.
  30
  Gross margin for
thesixmonths
endedJune 30, 2010totaled $11,477,300 of which 99% is attributable
to the sale of pharmaceutical products and the balance is attributable to our
stem cell collection operations.
 
 Operating Expenses
 
 Three
Months
Ended June 30, 2010Compared
to theThreeMonthsEnded
June 30, 2009
 
 For thethreemonths endedJune 30,
2010operating expenses
totaled $9,989,600  compared to $4,715,200 for
thethreemonths ended
June 30, 2009, representing an increase of $5,274,000  or 112%.
 
 For thethreemonths endedJune 30, 2010, our selling, general, and
administrative expenses were $7,856,500 compared to $4,199,900 for
thethree months ended June 30,
2009, representing an
increase of $3,665,800, which was the result
of:
 
 ·
              Our efforts to establish a stem
      cell operation in China to provide advanced therapies, related processing
      and storage, as well as research and development capabilitiestotaled $1,741,100, an increase of $587,900. Such expenses included
      expenditures for the rental of laboratory space, legal expenses associated
      with establishing our subsidiary company and related operations in China,
      consultants retained to support our implementation and introduction of
      advanced therapies in China, recruiting fees for identifying senior
      managers for our operation in China and travel. In addition these
      operating expenses reflect charges resulting from issuing various equity
      instruments to incentivize staff members and consultants totaling
      $746,500.
  ·
              Administrative expenses increased
      by approximately $1,105,600. Approximately $846,700 of this increased
      operating expense was the result of the Merger and the attendant operating
      expenses of the Erye operation. The Company’s US administrative operating
      expenses increased by $258,800. The use of equity instruments to
      incentivize staff, compensate directors and pay for services totaled
      $749,100, a decrease of $582,500 over thethreemonths endedJune 30,
      2009. Salaries and wages
      increased by $166,800 as the result of increased staffing levels,
      contractual salary increases, and bonus payments during the period. Other
      staff related cost including travel and entertainment and operating
      expenses increased $80,300 as result of our expanded operations in China.
      Professional fees, including legal and accounting fees increased by
      $390,300 as the result of our expanded operations in China.  
      Rent and other facility costs increased by $24,300 as a result of an
      increase in the cost of leasing of office space in New York and insurance
      expense increased $49,000. Compensation expenses under the Directors cash
      compensation plan adopted by the Board of Directors in the first quarter
      of 2009 increased administrative expense by $110,200. The balance of the
      increase in administrative expense was the result of offsetting changes
      from a variety of activities.
                
                Included in selling, general and
      administrative expense is a charge for $740,700 as the result of a
      judgment on May 13, 2010 against Erye in connection with a patent dispute
      concern an antibiotic product that has accounted for less than 2% of Erye
      sales in the past. (See Commitments and Contingencies for a more detailed
      discussion).
  ·
              As a result of completing the
      Merger with CBH, our activities associated with the Merger ended thus
      reducing the use of our attorney, accountant and other professional
      services and reducing ouroperating costs by $550,600over
  2009.
  ·
              Sales and marketing expenses
      increased by $1,782,000 over thethreemonths endedJune 30,
      2009. Approximately $575,600
      of this increased operating expense was related to the sales and marketing
      efforts of Erye and $383,400 related to amortization of intangible assets
      acquired in the Merger.  The use of equity instruments to
      incentivize staff and pay for services totaled $339,500, an increase of
      $127,600 overthreemonths endedJune 30,
      2009, and marketing and
      consulting fees increased approximately $583,200 in connection with developing
      new strategies and efforts to  increase our collection network
      and market penetration and our US sales and marketing costs also
      increased  by approximately $112,200 due to increases in staff
      costs and other operating
expenses.
  31
  For thethreemonths endedJune 30, 2010, our research and development expenses
totaled $2,133,200 compared to $515,300 for thethreemonths endedJune 30, 2009, representing an increase of
$1,617,900, which was the result of:
 
 The use of equity instruments to
incentivize research staff totaled $597,400, an increase of $497,900 over
thethreemonths endedJune 30, 2009. Research
related to our VSELTMtechnology increased operating expenses
by $753,700. Our acquisition of Erye added $369,400 of research and development
expense to our operating expenses. The balance of the increase in research and
development expense is related to costs associated with our wound healing
research.
  Six
Months Ended June 30, 2010Compared
to theSixMonthsEnded
June 30, 2009
  For thesixmonths endedJune 30,
2010operating expenses
totaled $17,588,500 compared to $6,593,700 for
thesixmonths ended
June 30, 2009, representing an increase of $10,994,800 or 167%.
 
 For thesix months endedJune 30, 2010, our selling, general,
and administrative expenses were $14,155,000 compared to $5,823,800 for
thesixmonths endedJune 30, 2009, representing
an increase of $8,331,200, which was the result
of:
 
 ·
              Our efforts to establish a stem
      cell operation in China to provide advanced therapies, related processing
      and storage, as well as research and development capabilitiestotaled $2,932,900, an increase of
      $1,794,500. Such expenses included
      expenditures for the rental of laboratory space, legal expenses associated
      with establishing our subsidiary company and related operations in China,
      consultants retained to support our implementation and introduction of
      advanced therapies in China, recruiting fees for identifying senior
      managers for our operation in China and travel. In addition these
      operating expenses reflect charges resulting from issuing various equity
      instruments to incentivize staff members and consultants totaling
      $1,298,000.
  ·
              Administrative expenses increased
      by approximately $3,882,100. Approximately $1,579,000 of this increased
      operating expense was the result of the Merger and the attendant operating
      expenses of the Erye operation. The Company’s US administrative operating
      expenses increased by $2,303,100. The use of equity instruments to
      incentivize staff, compensate directors and pay for services totaled
      $1,616,300, an increase of $333,000 oversixmonths endedJune 30,
      2009. Salaries and wages
      increased by $707,600 as the result of increased staffing levels,
      contractual salary increases, bonus payments and tax payments and tax
      withholdings we paid on behalf of certain executive and other staff
      members.  Professional fees, including legal and accounting fees
      increased by $528,800 as the result of our expanded operations in China.
      Investor relations services increased by $150,300, including fees for
      preparing documents for various SEC filings and increased communications
      with shareholders and investors.  Other staff related cost
      including travel and entertainment and operating expenses increased
      $137,200 as result of our expanded operations in China, rent increased by
      $76,900 as a result of an increase in the cost of leasing of office space
      in New York, and franchise taxes increased $111,200. Compensation
      expense under the Directors cash compensation plan adopted by the Board of
      Directors in the first quarter of 2009 increased administrative expense by
      $186,300, insurance increased $99,000 and the  balance of the
      changes in administrative expense resulted from increases and decreases in
      other operating activities.
                
                Included in selling, general and
      administrative expense is a charge for $740,700 as the result of a
      judgment on May 13, 2010 against Erye in connection with a patent dispute
      concern an antibiotic product that has accounted for less than 2% of Erye
      sales in the past. (See Commitments and Contingencies for a more detailed
      discussion).
  ·
              As a result of completing the
      Merger with CBH, our activities associated with the Merger ended thus
      reducing the use of our attorney, accountant and other professional
      services and reducing ouroperating costs by $835,100overthe same period in2009.
  32
  ·
              Sales and marketing expenses
      increased by $2,748,900 oversixmonths endedJune 30,
      2009. Approximately
      $1,099,400 of this increased operating expense was related to the sales
      and marketing efforts of Erye and $766,800 related to amortization of
      intangible assets acquired in the Merger.  The use of equity
      instruments to incentivize staff and pay for services totaled $495,600, an
      increase of $242,000 oversixmonths endedJune 30,
      2009, and marketing and
      consulting fees increased approximately $524,000 in connection with
      developing new strategies and efforts to  increase our
      collection network and market penetration. Our US sales and marketing
      costs also increased  by approximately $116,600 due to increases
      in staff costs and other operating
  expenses.
 
 For thesixmonths endedJune 30, 2010, our research and development expenses
totaled $3,433,500 compared to $769,900 for thesixmonths endedJune 30, 2009, representing an increase of
$2,663,600, which was the result of:
 
 The use of equity instruments to
incentivize research staff totaled $741,200, an increase of $604,400 over
thesixmonths endedJune 30, 2009. Research
related to our VSELTMtechnology increased operating expenses
by $1,572,900. Our acquisition of Erye added $487,400 of research and
development expense to our operating expenses. The balance of the increase in
research and development expense is related to costs associated with our wound
healing research.
 
 Dividends on Convertible Redeemable
Series C Preferred Stock.
 
 In connection with the Merger, the
Company issued 8,177,512 shares of Convertible Redeemable Series C Preferred
Stock (“Series C Preferred Stock”) which called for an annual dividend of
5% based on the stated value of the preferred stock. For thethree
and six months
endedJune 30, 2010we recorded a dividend of $53,800
and $153,500 , respectively, as the prorated dividend due.On
May 17, 2010, RimAsia Capital Partners LP ("RimAsia"), converted its
8,177,512 shares of Series C Preferred Stock into 9,086,124 shares of the
Company's common stock.Following this conversion,
there are no shares of Series C Preferred Stock outstanding and RimAsia will not
be entitled to receive any dividends on such shares, to receive notices or to
vote such shares or to exercise or to enjoy any other powers, preferences or
rights in respect thereof; provided however that RimAsia was entitled to receive
a cash payment of $153,469 which is equal to the dividends accrued but unpaid
from January 1, 2010 through May 17, 2010.  This payment was made
on May 25, 2010.
  Noncontrolling
Interests
 
 When the Company acquired China
Biopharmaceutical Holdings, Inc. it acquired a 51% interest in Erye
Pharmaceutical Co. Ltd. (“Erye”).  In preparing our financial
statements the full operations of Erye are reflected in these results as of
October 30, 2009. We account for the 49% minority shareholder share of Erye’s
net income with a charge to Noncontrolling Interests. For thethree
and sixmonths
endedJune 30, 2010Erye’s minority shareholders’
share of net income totaled $1,611,500 and $2,940,200,
respectively.
 
 Other Income and
Expense
 
 For thethree
and sixmonths
endedJune 30, 2010the Company incurred interest
expense of approximately $139,700 and $252,900 respectively primarily related to
a loan to Erye from its minority shareholder, of which $133,500 and $238,200 was
capitalized for thethree and sixmonths endedJune 30,
2010, respectively as part of the
cost of construction of Erye’s new manufacturing plant. In accordance with the
Joint Venture Agreement that governs the operation of Erye the minority
shareholder has agreed to loan back to Erye dividends it is entitled to for
three years starting in 2008, to help fund the construction of the new
manufacturing facility. AtJune 30, 2010these loans totaled $7,855,200.
The loan calls for interest to accrue at a rate of 5%
annually.
  For the three months ended June 30, 2010
the Company recognized other income of $149,600 in connection with the
extinguishment of certain liabilities that Erye determined were no longer
payable, and for the six months ended June  30, 2010 the Company
recognized $14,500 of other expenses that were the result of interest income and
other income credits offset by expenses related to the restructuring of the
term of certain warrants issued to RimAsia of approximately
$188,000.
  33
  Provision for taxes
 
 The provision for taxes of $402,300 and
$905,200 represents income taxes due on income of Erye for thethree
and sixmonths endedJune 30, 2010, respectively
and is net of utilization of the deferred tax liability associated with
amortization of intangible assets acquired in the merger of $60,600 and $121,200
for the respective periods.
 
 Liquidity and Capital
Resources
 
 AtJune 30, 2010we had a cash balance of $10,958,800, working capital of $12,082,000 and stockholders’ equity of
$47,802,700.  During the six months
ended June 30, 2010we invested approximately $8.6 million into the
business, specifically in property and equipment related to our expansion into
China, while reducing cash used in operating activities by $2.6 million compared
to the first six months of 2009.
 
 During thesix months endedJune 30, 2010, we met our immediate cash requirements
through existing cash balances, public offerings of our common stock which
raised approximately $13.6million, the exercise of warrants and
options which raised approximately $2.6 million, the issuance of notes payable
for our operations in China and the use of equity and equity-linked instruments
to pay for services and compensation.
 
 We incurred a net loss attributable to
common shareholders of $5,427,100 and $10,139,300for thethree and sixmonths endedJune 30,
2010, respectively. The following
chart represents the net funds provided by or used in operating, financing and
investment activities for each period indicated (in
thousands):
  The Six Months
      Ended(in $000)
                
                June 30,
    2010
                
                
                June 30,
    2009Cash (used) in operating
      activities
                
                $
                (3,464.4
                )
                
                $
                (5,221.2
                )Cash (used) in investing
      activities
                
                
                (8,034.1
                )
                
                
                (80.9
                )Cash provided by financing
      activities
                
                
                15,200.7
                
                
                
                15,320.9
  Operating Activities
 
 Our cash used for operating activities
in thesixmonths
endedJune 30, 2010totaled $3,464,500, which is the sum of (i) our net loss,
adjusted for non-cash expenses totaling $5,804,900which includes, principally, common
stock, common stock options and common stock purchase warrants issued for
services rendered in the amount of $4,339,700 and depreciation and amortization of
$1,465,200; (ii) cash retained in the operation
as the result of increases in accounts payable and accrued expenses of
$2,258,100; and (iii)a decrease in cash resulting from a
reduction in advance payments and unearned revenue from customers and licensees
of $647,700, an increase in accounts receivable of $286,200, cash used for prepaids and payments of
other assets of $157,800and increases in inventory of
$3,331,700.
  Under a License Agreement entered into
with the University of Louisville Research Foundation (“ULRF”) in November 2007,
SCTI agreed to engage in a diligent program to develop the VSELTM technology.
Certain license fees and royalties are to be paid to ULRF from SCTI, and SCTI is
responsible for all payments for patent filings and related applications.
Portions of the license may be converted to a non-exclusive license if SCTI does
not diligently develop the VSELTM technology or terminated entirely if SCTI
chooses to not pay for the filing and maintenance of any patents thereunder.
Under the License Agreement, which has an initial term of 20 years, the Company
has paid to date approximately $117,000 consisting of various up-front fees,
including $22,000 in connection with its May 2010 amendment, and is required to
pay under the license certain other future fees including: (i) a specified
non-refundable annual license maintenance fee upon issuance of the licensed
patent in the United States; (ii) a specified royalty on net sales; (iii)
specified milestone payments; and (iv) specified payments in the event of
sublicensing.  The License Agreement also contains certain provisions
relating to "stacking," permitting SCTI to pay royalties to ULRF at a reduced
rate in the event it is required to also pay royalties to third parties
exceeding a specified threshold for other technology in furtherance of the
exercise of its patent rights or the manufacture of products using the VSELTM
technology.
  Investing
Activities
 
 During thesixmonths ended June 30, 2010 we spent
approximately $8.6million for property and equipment.
Erye is building a new production facility and during thesixmonths endedJune 30,
2010$8.2million was spent on
construction.  This plant is expected to be fully operational in 2011.
In March 2010 we initiated construction of our stem cell laboratory in Beijing
and to date we have invested $770,000.  The balance of our capital
expenditures was spent on equipping our laboratory in Boston and other Company
stem cell operations in China. The new
production facility will increase Erye’s production capacity and should enable
Erye to respond to expected increases in demand for pharmaceutical products in
China.
  Idle cash
in our Erye subsidiary of approximately $2.4 million was invested on short term
investments and proceeds from these investments of approximately $2.4 million
was used for various operating and financing activities in the six months ended
June 30, 2010.
  34
  Financing Activities
  In December 2009, in order to facilitate
working capital requirements, in local currency, in China, NeoStem (China)
issued a promissory note to the Bank of Rizhao Qingdao Branch in the amount of
4,400,000 RMB (approximately $645,500). The note, bearing an interest rate of
4.05%, was due on June 21, 2010 and paid in full in April 2010.On May
25, 2010 NeoStem (China) issued a promissory note to the Bank of Rizhao Qingdao
Branch in the amount of 3,600,000 RMB (approximately $527,400) due November 25,
2010 and bearing interest at 4.86% per annum.  The loan is collateralized
by cash in a restricted bank account totaling 4,074,500 RMB (approximately
$600,200). In addition, in May 2010 NeoStem (China) entered into a pledge
agreement with the bank pledging all of its interest in its VIEs as additional
collateral for the loan.
  The Company’s subsidiary Erye has
69,749,400 RMB (approximately $10,274,000) of notes payables as
ofJune 30, 2010and62,457,000 RMB (approximately
$9,150,000) of notes payable as of December 31, 2009. Notes are payable to the banks who
issue bank notes to Erye’s creditors. Notes payable are interest free and
usually mature after a three to six months period.  In order to issue
notes payable on behalf of Erye, the banks required collateral, such as cash
deposits which were approximately 30%-50% of the value of notes to be issued, or
properties owned by Erye. AtJune 30, 2010, 23,734,500 RMB (approximately
$3,496,100) of restricted cash was put up for collateral for the balance of
notes payable which was approximately 34% of the notes payable the Company
issued, and the remaining of the notes payable is collateralized by pledging the
land use right the Company owns.  The use of notes payable to pay
creditors is a feature of the money and banking system of China and we expect
these types of notes to be a continuing feature of Erye’s capital
structure.
 
 On February 18, 2010 the Company
completed a public offering of its common stock, selling 5,750,000 shares priced
at $1.35 per share. The Company received approximately $6,822,000 in net
proceeds from the offering, after underwriting discounts, commissions and other
expenses, of approximately $940,000 of which 463,000 was
unpaid.
 
 On March 15, 2010, the Company and
RimAsia made certain agreements with respect to outstanding
warrants.  RimAsia exercised its warrant to purchase 1,000,000 shares
of the Company’s common stock, par value $0.001 per share (“ Common Stock ”),
exercisable at a per share exercise price of $1.75, which was  issued
to RimAsia in a private placement completed by the Company in September
2008.  This exercise resulted in proceeds to the Company totaling
$1,750,000.  The condition for such exercise was that the Company
would modify certain terms of RimAsia’s warrant to purchase 4,000,000 shares of
Common Stock, issued to RimAsia in a private placement completed by the Company
in April 2009 (the “Series D Warrant”).  The Series D
Warrant  was  amended to provide for (i) a three (3) year
extension of the Termination Date (as defined in the Series D Warrant) from
September 1, 2013 to September 1, 2016 and (ii) an increase in the average
closing price that triggers the Company’s redemption option under the Series D
Warrant from $3.50 to $5.00.
 
 On May
19, 2010, the Company entered into a Common Stock Purchase Agreement with
Commerce Court Small Cap Value Fund, Ltd., which provides that, subject to
certain terms and conditions, Commerce Court is committed to purchase up to
$20,000,000 worth of shares of the Company’s common stock over a term of
approximately 24 months.  The Purchase Agreement provides that at the
Company’s discretion, it may present Commerce Court with draw down notices under
this $20 million equity line of credit arrangement from time to time, to
purchase the Company’s Common Stock, provided certain price requirements are met
and limited to 2.5% of the Company’s market capitalization at the time of such
draw down.  The per share purchase price for these shares will equal
the daily volume weighted average price of the Company’s common stock on each
date during the draw down period on which shares are purchased, less a discount
of 5.0%.  The Purchase Agreement also provides that the Company in its sole
discretion may grant Commerce Court the right to exercise one or more options to
purchase additional shares of Common Stock during each draw down period at a
price which would be based on a discount calculated in the same manner as it is
calculated in the draw down notice. The issuance of shares of common stock to
Commerce Court pursuant to the Purchase Agreement, and the sale of those shares
from time to time by Commerce Court to the public, are covered by an effective
registration statement on Form S-3 filed with the SEC.
 
 On May
27, 2010, the Company presented Commerce Court with a Draw Down
Notice.  Pursuant to the Purchase Agreement, the shares were offered
at a discount price to Commerce Court mutually agreed upon by the parties under
the Purchase Agreement equal to 95.0% of the daily volume weighted average price
of the common stock during the Pricing Period or a 5%
discount.  Pursuant to the Draw Down Notice, the Company also granted
Commerce Court the right to exercise one or more options to purchase additional
shares of common stock during the Pricing Period, based on the trading price of
the common stock. The Company settled with Commerce Court on the purchase of
685,226 shares of common stock under the terms of the Draw Down Notice and the
Purchase Agreement at an aggregate purchase price of $1.8 million,
or approximately $2.63 per share, on June 7, 2010.  The Company and
Commerce Court agreed to waive the minimum threshold price of $3.00 per share
set forth in the Purchase Agreement.  The Company received net proceeds
from the sale of these shares of approximately $1.7 million after deducting its
offering expenses.
 
 Effective
June 1, 2010, Fullbright exercised a warrant to purchase 400,000 shares of
restricted Common Stock.  This
warrant was issued to Fullbright in a private placement of securities by the
Company in November 2008.  The exercise price was $1.75 per share,
resulting in proceeds to the Company of $700,000.
 
 On June
25, 2010, the Company entered into definitive securities purchase agreements
with investors in a public offering, pursuant to which such investors agreed to
purchase, and the Company agreed to sell, an aggregate of 2,325,582 Units,
consisting of an aggregate of 2,325,582 shares of Common Stock and warrants to
purchase an aggregate of 581,394 shares of Common Stock.  The offering
closed on June 30, 2010 with gross proceeds of $5.0 million.  Each
Unit was priced at $2.15 and consisted of one share of common stock and a
warrant which will allow the investor to purchase 0.25 shares of common stock at
a per share price of $2.75.  The warrants may be called by the Company
in the event that the common stock trades over $4.50 per share for 10
consecutive trading days.  Subject to certain ownership limitations,
the warrants were exercisable on the date of the closing and will expire 2 years
thereafter.  The number of shares of Common Stock issuable upon
exercise of the warrants and the exercise price of the warrants are adjustable
in the event of stock dividends, splits, recapitalizations, reclassifications,
combinations or exchanges of shares, reorganizations, liquidations,
consolidation, acquisition of the Company (whether through merger or acquisition
of substantially all the assets or stock of the Company) or similar
events.  The net proceeds to the Company from such offering, after
deducting the Placement Agent’s fees and expenses, the Company’s estimated
offering expenses, and excluding the proceeds, if any, from the exercise of the
warrants issued in the offering were approximately $4.55
million.
  35
  Pursuant to the terms and conditions of
the Joint Venture Agreement, dividend distributions to EET and Merger Sub will
be made in proportion to their respective ownership interests in Erye; provided,
however, that for the three-year period commencing on the first day of the first
fiscal quarter after the Joint Venture Agreement becomes effective distributions
will be made as follows: (i) the 49% of undistributed profits (after tax) of the
joint venture due EET will be distributed to EET and lent back to Erye to help
finance costs in connection with their construction of and relocation to a new
facility; and (ii) of the net profit (after tax) of the joint venture due Merger
Sub, 45% will be provided to Erye as part of the new facility construction fund
and will be characterized as paid-in capital for Merger Sub’s 51% interest in
Erye, and 6% will be distributed to Merger Sub directly.  At June 30,
2010 these loans totaled $7,702,800 plus accrued interest of $227,500. The loan
calls for interest to accrue at rate of 5% annually.  In addition,
during the second quarter EET received an interest payment of approximately
$192,000.
 
 Liquidity and Capital Requirements
Outlook
 
 With our acquisition of a controlling
interest in Erye and expansion into China, we have transitioned from being a
one-dimensional U.S. service provider with nominal revenues to being a
multi-dimensional international biopharmaceutical company with current revenues
and operations in three distinct business units — U.S. adult stem cells, China
adult stem cells and China pharmaceuticals. The following is an overview of our
collective liquidity and capital requirements.
 
 Erye is constructing a new
pharmaceutical manufacturing facility and began transferring its operations in
January 2010.  The relocation will continue as the new production
lines are completed and receive cGMP certification through 2011. The new
facility is estimated to cost approximately $30 million, of which approximately
$24 million has been incurred through June 30, 2010. Construction has been and
will continue to be self-funded by Erye and EET, the holder of the minority
joint venture interest in Erye. We have agreed for a period of three years to
reinvest in Erye approximately 90% of the net earnings we would be entitled to
receive under the Joint Venture Agreement by reason of our 51% interest in
Erye.
  We are also engaged in other initiatives
to expand our operations into China including with respect to technology
licensing, establishment of stem cell processing and storage capabilities and
research and clinical development. In June 2009 we established NeoStem (China)
as our wholly foreign-owned subsidiary. To comply with PRC’s foreign investment
regulations regarding stem cell research and development, clinical trials and
related activities, we conduct our current stem cell business in the PRC through
two domestic variable interest entities. We have incurred and expect to continue
to incur substantial expenses in connection with our China
activities.  In order to implement the establishment of the Beijing
Facility, as of December 31, 2009, our Company, our WFOE  subsidiary
NeoStem (China), and PCT entered into the PCT Agreement, whereby NeoStem and
NeoStem (China) engaged PCT to perform the services necessary (1) to construct
the Beijing Facility, consisting of a clean room for adult stem cell clinical
trial processing and other stem cell collections which will have the processing
capacity on an annual basis sufficient for at least 10,000 samples, research and
development laboratory space, collection and stem cell storage area and offices,
together with the furnishings and equipment, and (2) to effect the installation
of quality control systems consisting of materials management, equipment
maintenance and calibration, environmental monitoring and compliance and adult
stem cell processing and preservation which comply with cGMP standards and
regulatory standards that would be applicable in the United States under GTP
standards, as well as all regulatory requirements applicable to the program
under the laws of the PRC.  The aggregate cost of the program,
including the Phase 1 equipment purchases, is expected to be approximately
$3,000,000. The project commenced on April 1, 2010, and is anticipated to take
approximately seven months to complete. We have the option to terminate the PCT
Agreement without cause upon providing no less than 60 days written notice to
PCT, subject to our obligation to pay for any services performed up to the date
of termination and certain costs and expenses incurred by
PCT.
 
 We expect to rely partly on dividends
paid to us by the WFOE under the contracts with the VIEs, and under the Joint
Venture Agreement, attributable to our 51% ownership interest in Erye, to meet
our future cash needs. However, there can be no assurance that the WFOE in China
will receive payments uninterrupted or at all as arranged under the contracts
with the VIEs. In addition, pursuant to the Joint Venture Agreement that governs
the ownership and management of Erye, for the next three years: (i) 49% of
undistributed profits (after tax) will be distributed to EET and loaned back to
Erye for use in connection with its construction of the new Erye facility; (ii)
45% of the net profit after tax will be provided to Erye as part of the new
facility construction fund, which will be characterized as paid-in capital for
our 51% interest in Erye; and (iii) only 6% of the net profit will be
distributed to us directly for our operating expenses.
  36
  The payment of dividends by entities
organized under PRC law to non-PRC entities is subject to limitations.
Regulations in the PRC currently permit payment of dividends by our WFOE and
Erye only out of accumulated distributable earnings, if any, as determined in
accordance with accounting standards and regulations in China. Moreover, our
WFOE and Erye 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 oftherelevant
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 WFOE
and Erye. In addition, if Erye incurs debt on its own behalf in the future, the
instruments governing the debt may restrict Erye’s or the joint venture’s
ability to pay dividends or make other distributions to us. This may diminish
the cash flow we receive from Erye’s operations, which would have a material
adverse effect on our business, operating results and financial
condition.
 
 Our interests in China will be subject
to China’s rules and regulations on currency conversion. In particular, the
initial capitalization and operating expenses of the two VIEs are funded by our
WFOE. In China, the State Administration for Foreign Exchange, or the SAFE,
regulates the conversion of the Chinese Renminbi into foreign currencies.
Currently, foreign investment enterprises are required to apply to the SAFE for
Foreign Exchange Registration Certificates, or IC Cards of Enterprises with
Foreign Investment. Foreign investment enterprises holding such registration
certificates, which must be renewed annually, are allowed to open foreign
currency accounts including a “basic account” and “capital account.” Currency
translation within the scope of the “basic account,” such as remittance of
foreign currencies for payment of dividends, can be effected without requiring
the approval of the SAFE. However, conversion of currency in the “capital
account,” including capital items such as direct investments, loans, and
securities, require approval of the SAFE. According to theNotice
of the General Affairs Department of the State Administration of Foreign
Exchange on the Relevant Operating Issues Concerning the Improvement of the
Administration of Payment and Settlement of Foreign Currency Capital of
Foreign-invested Enterprisespromulgated on August 29,
2008, or the SAFE Notice 142, to apply to a bank for settlement of foreign
currency capital, a foreign invested enterprise shall submit the documents
certifying the uses of the RMB funds from the settlement of foreign currency
capital and a detailed checklist on use of the RMB funds from the last
settlement of foreign currency capital. It is stipulated that only if the funds
for the settlement of foreign currency capital are of an amount not more than
US$50,000 and are to be used for enterprise reserve, the above documents may be
exempted by the bank. This SAFE Notice 142, along with the recent practice of
Chinese banks of restricting foreign currency conversion for fear of “hot money”
going into China, have limited and may continue to limit our ability to channel
funds to the two VIE entities for their operation. We are exploring options with
our PRC counsels and banking institutions in China as to acceptable methods of
funding the operation of the two VIEs, including advances from Erye, but there
can be no assurance that acceptable funding alternatives will be
identified.
  Neither Erye nor our other expansion
activities into China are expected to generate sufficient excess cash flow to
support our platform business or our initiatives in China in the near
term.
 
 Although the Company does not have
immediate plans to raise capital, we believe that we will need to raise
additional capital to fund the development of advanced stem cell technologies
and therapies in the U.S. and China, including the VSELTMtechnology licensed from the University
of Louisville and other regenerative technologies. We currently expect to fund
our operating activities in the near term through the use of existing cash
balances and moving forward through the use of a current equity line or other
capital raising transaction, potential additional warrant and option exercises,
the 6% of net profits to which we are entitled from Erye, and, ultimately, the
growth of our revenue generating activities in China. In addition, we will
continue to seek grants for scientific and clinical studies from the National
Institutes of Health and other governmental agencies and foundations, but there
can be no assurance that we will be successful in obtaining such
grants.  We also review acquisition opportunities for revenue
generating businesses around which we could consider raising
capital.  AtJune 30, 2010, we had a cash balance of approximately
$10.9 million.  The trading volume of our common stock, coupled with
our history of operating losses and liquidity problems, may make it difficult
for us to raise capital on acceptable terms or at all. The demand for the equity
and debt of small cap biopharmaceutical companies like ours is dependent upon
many factors, including the general state of the financial markets. During times
of extreme market volatility, capital may not be available on favorable terms,
if at all. Our inability to obtain such additional capital on acceptable terms
could materially and adversely affect our business operations and ability to
continue as a going concern.
 
 37
  The following table reflects a summary
of NeoStem’s contractual cash obligations as ofJune 30, 2010(in
thousands):
  Total
                
                
                Less than 1
      Year
                
                
                1- 3 Years
                
                
                3-5 Years
                
                
                More than 5
      YearsEmployment
      Agreements
                
                $
                4,231.7
                
                
                $
                2,252.0
                
                
                $
                1,979.7
                
                
                $
                -
                
                
                $
                -Facility
    Leases
                
                
                2,170.2
                
                
                
                958.5
                
                
                
                1,211.7
                
                
                
                -
                
                
                
                -License
Fees
                
                
                180.1
                
                
                
                30.1
                
                
                
                90.0
                
                
                
                60.0
                
                
                
                -Sponsored Research Agreement with
      the University of Louisville
                
                
                138.2
                
                
                
                86.1
                
                
                
                52.1
                
                
                
                -
                
                
                
                -Consulting
      Agreements
                
                
                1,339.4
                
                
                
                1,017.4
                
                
                
                322.0
                
                
                
                -
                
                
                
                -Design & Construction of
      Laboratory
                
                
                1,828.6
                
                
                
                1,828.6
                
                
                
                -
                
                
                
                -
                
                
                
                -Director
    Fees
                
                
                180.0
                
                
                
                180.0
                
                
                
                -
                
                
                
                -
                
                
                
                -$
                10,068.2
                
                
                $
                6,352.7
                
                
                $
                3,655.5
                
                
                $
                60.0
                
                
                $
                -
  SEASONALITY
 
 NeoStem does not believe that its
operations are seasonal in nature.
 
 OFF-BALANCE SHEET
ARRANGEMENTS
 
 NeoStem does not have any off-balance
sheet arrangements.
 
 CAUTIONARY NOTE REGARDING
FORWARD-LOOKING STATEMENTS
 
 This
Quarterly Report on Form 10-Q includes “forward-looking” statements as well as
historical information. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause our actual
results, performance or achievements, or industry results, to be materially
different from anticipated results, performance or achievements expressed or
implied by such forward-looking statements. When used in this report, statements
that are not statements of current or historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words “plan,”
“intend,” “may,” “will,” “expect,” “believe,” “could,” “anticipate,” “estimate,”
or “continue” or similar expressions or other variations or comparable
terminology are intended to identify such forward-looking statements.
Additionally, statements concerning our ability to successfully develop the
adult stem cell business at home and abroad, the future of regenerative medicine
and the role of adult stem cells in that future, the future use of adult stem
cells as a treatment option and the role of VSELTM
technology in that future, and the potential revenue growth of such business are
forward-looking statements. Our future operating results are dependent upon many
factors, and our further development is highly dependent on future medical and
research developments and market acceptance, which is outside its control.
Forward-looking statements may not be realized due to a variety of factors,
including, without limitation, (i) our ability to manage the business despite
continuing operating losses and cash outflows; (ii) our ability to obtain
sufficient capital or a strategic business arrangement to fund our operations
and expansion plans, including meeting our financial obligations under various
licensing and other strategic arrangements and the successful commercialization
of the relevant technology; (iii) our ability to build the management and human
resources and infrastructure necessary to support the growth of the business;
(iv) competitive factors and developments beyond our control; (v) scientific and
medical developments beyond our control; (vi) our inability to obtain
appropriate governmental licenses or any other adverse effect or limitations
caused by government regulation of the business; (vii) whether any of our
current or future patent applications result in issued patents and our ability
to obtain and maintain other rights to technology required or desirable for the
conduct of our business; (viii) whether any potential strategic benefits of
various licensing transactions will be realized and whether any potential
benefits from the acquisition of these new licensed technologies will be
realized; (ix) whether we can obtain the consents we may require to sublicensing
arrangements from technology licensors in connection with technology
development; (x) our ability to maintain our NYSE Amex listing; (xi) factors
regarding our business in China and, generally, regarding doing business in
China, including through our variable interest entity structure; and (xii) the
other factors discussed in “Risk Factors” and elsewhere in this Quarterly Report
on Form 10-Q, in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2009 under the heading “Part I — Item 1A. Risk Factors”
and in other periodic Company filings with the Securities and Exchange
Commission.  The Company’s filings with the Securities and Exchange
Commission are available for review at www.sec.gov under
“Search for Company Filings.”
 
 All
forward-looking statements attributable to us are expressly qualified in their
entirety by these and other factors. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof.  With respect to these forward-looking statements, we claim
the protection of the safe harbor for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995.  Actual results
could differ materially from those anticipated in the forward-looking statements
and from historical results, due to the uncertainties and factors described
above, as well as others that we do not anticipate at this
time.  Except as required by law, the Company undertakes no obligation
to update any forward-looking statements, whether as a result of new
information, future events or otherwise.
  38
  ITEM 3.  QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
 Not applicable to smaller reporting
companies.
 
 ITEM 4.  CONTROLS AND
PROCEDURES
 
 (a)  Disclosure Controls and
Procedures
 
 Disclosure controls and procedures are
the Company’s controls and other procedures that are designed to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”) is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission’s rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in the
reports that the Company files under the Exchange Act is accumulated and
communicated to management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.  Due to the inherent limitations of control systems, not
all misstatements may be detected. These inherent limitations include the
realities that judgments in decision-making can be faulty and the breakdowns can
occur because of a simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. Controls and procedures can
only provide reasonable, not absolute, assurance that the above objectives have
been met.
 
 As of the end of the Company's quarter
endedJune 30, 2010covered by this report, the
Company carried out an evaluation, with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the Company's disclosure controls and
procedures pursuant to Rule 13a-15 of the Exchange Act.  Based on that
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that due to the material weaknesses discussed below the Company's
disclosure controls and procedures were not effective, at the reasonable
assurance level, in ensuring that information required to be disclosed by the
Company in the reports that it files or submits under the Securities Exchange
Act is recorded, processed, summarized and reported, within the time periods
specified in the SEC's rules and forms and is accumulated and communicated to
management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required
disclosure.
 
 CBH, which was acquired by the Company
on October 30, 2009, previously identified the material weaknesses identified
below.  Because the acquisition was completed in the fourth quarter of
2009, the Company has not had sufficient time to remediate the material
weaknesses previously identified by CBH.  However, since the filing
date of the Company’s quarterly report on Form 10-Q for the quarter ended March
31, 2010 the Company has made additional progress in remediating the material
weaknesses previously identified by CBH.
 
 Prior to the Merger, in its assessment
of its internal control over financial reporting as of December 31, 2008, CBH
identified in substance the material weaknesses set forth below.  As
of September 30, 2009, CBH reported that such material weaknesses had not been
remediated and continued to exist.
 
 1. Insufficient U.S. GAAP qualified
accounting and finance personnel.
 As the U.S. GAAP closing process related
to non-routine transactions and estimates, CBH did not have sufficient US GAAP
qualified accounting and finance personnel necessary to close its books at its
subsidiaries in China.  CBH's subsidiaries in China did not maintain
books and records in accordance with US GAAP and had to make adjusting entries
to prepare and report financial statements in accordance with US
GAAP.  Because the accounting personnel were not familiar with US GAAP
non-routine transactions and estimates were not properly accounted for under US
GAAP. This material weakness resulted in adjustments to several significant
accounts and disclosures and contributed to other material weaknesses described
below.
 
 2. Lack of Internal Audit
System.
 CBH did not have an internal audit
department and therefore was unable to effectively prevent and  detect
control  lapses and errors in the  accounting of certain key
areas like revenue  recognition,  purchase
approvals,  inter-company
transactions,  cash  receipt  and
cash  disbursement  authorizations,  inventory
safeguard and proper  accumulation for cost of products,  in
accordance with the appropriate costing method used by CBH.
 
 3. Financial Statement Closing
Process.
 CBH's controls over the financial
statement close process related to account reconciliation and analyses,
including bank accounts, certain long-lived assets and accrued liabilities, were
not effective. As a result, a large volume of adjustments were necessary to
completely and accurately present the financial statements in accordance with US
GAAP.
  39
  As of June 30, 2010,the Company was unable to conclude that
the above material weaknesses previously reported by CBH had been fully
remediated.
 
 Since the acquisition of CBH in the
fourth quarter of 2009, the Company has been in the process of implementing the
following remediation plans.
 
 While the Company has sufficient US GAAP
qualified accounting and financial personnel at the parent level, the accounting
and financial accounting personnel at Company’s subsidiary, Erye, continue to
need additional training on US GAAP.  The Company is seeking to
remediate this by deploying its finance and accounting personnel to Erye to
account for non-routine, complex transactions at the Erye level and to assist
with Erye’s closing processes from time to time and use the services of another
accounting firm for this role as well as to provide additional training on US
GAAP to Erye’s personnel so they can do the accounting for Erye without
significant participation from the Company’s finance and accounting
personnel.
 
 The Company does not believe its size
warrants an internal audit staff. The Company engaged a public accounting firm
to provide internal audit services in 2010, including to review and assess key
risk areas such as revenue recognition, purchase approvals, inter-company
transactions, cash receipt and cash disbursement authorizations, inventory
safeguard and proper accumulation for cost of products as well as complex,
non-routine transactions and will participate in the closing
processes.
 
 The parent Company’s Chief Financial
Officer and Vice President of Finance, each of whom is US GAAP qualified, are
participating in the quarterly financial statement closing process at the Erye
subsidiary. The Company has established a process whereby the accounting
reconciliation and analyses prepared by Erye as part of the financial statement
closing process are reviewed by the parent Company’s Chief Financial Officer and
its Vice President of Finance.
 
 In addition, the Company believes that
the oversight provided by its audit committee, which, unlike CBH's audit
committee, is comprised of three independent and financially sophisticated
members, at least one of whom qualifies as an “audit committee financial expert”
as defined in applicable SEC rules, will support and further the remediation
steps set forth above.
 
 (b) Changes in Internal Control over
Financial Reporting
 
 There have been no changes in the
Company's internal controls over financial reporting, as such term is defined in
Exchange Act Rule 13a-15, that occurred during the Company's last fiscal quarter
to which this report relates that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting, except that during the last fiscal quarter ended March 31, 2010 we
extended the parent company internal controls to our new operations in China and
these changes continued in the three months ended June 30,
2010.
 
 40
  NEOSTEM, INC.
 PART II
 
 OTHER INFORMATION
 
 ITEM 1. LEGAL
PROCEEDINGS
 
 There are no material changes to the
disclosures provided in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2009.
 
 ITEM 1A. RISK
FACTORS
 
 We are a company with a limited
operating history and have incurred substantial losses and negative cash flow
from operations in the past, and we expect to continue to incur losses and
negative cash flow for the near term.
 
 We are a company with a limited
operating history, limited capital, and limited sources of revenue. Since our
inception in 1980, we have incurred net losses of approximately $81.8 million
throughJune 30, 2010.  We incurred net losses
attributable to common shareholders of approximately $10.1 million for
thesixmonth period
endedJune 30, 2010,
approximately$25.3 million
for the year ended December 31, 2009 and approximately $9.2 million for the year
ended December 31, 2008,and we expect to incur additional operating losses and negative cash flow in the
future. The revenues from our adult stem cell collection, processing and storage
business are not sufficient to cover costs attributable to that business. We
expect to incur losses and negative cash flow for the foreseeable future as a
result of our activities under license and sponsored research agreements
relating to our VSELTMtechnology and other research and
development efforts to advance stem cell and other therapeutics, both in the
U.S. and China.  We also expect to continue to incur significant
expenses related to sales, marketing, general and administrative and product
research and development in connection with the development of our
business.
 
 Although Erye, a Chinese pharmaceutical
company in which we recently acquired a 51% interest, had revenue of $35.2
million for thesixmonths endedJune 30, 2010and $11.6 million in revenue
for the year ended December 31, 2009 (this reflects Erye’s operations for the
two months ended December 31, 2009 since the merger was effective October 30,
2009), it has only a limited history of earnings. Moreover, Erye is expected to
incur significant expenses in the near term due to: (1) costs related to
stabilizing and streamlining its operations; (2) costs related to the relocation
of its production operations to a new facility currently under construction; (3)
research and development costs related to new drug projects; and (4) costs
related to expanding its existing sales network for new drug distribution.
Pursuant to the current joint venture agreement that governs the ownership and
management of Erye, or the Joint Venture Agreement, which has been approved in
principle by PRC governmental authorities, for the next three years (i) 49% of
undistributed profits, after tax, will be distributed to Suzhou Erye Economy and
Trading Co. Ltd., or EET, which owns the remaining 49% of Erye, and loaned back
to Erye for use in connection with its construction of the new Erye facility;
(ii) 45% of the net profit after tax will be provided to Erye as part of the new
facility construction fund, which will be characterized as paid-in capital for
our 51% interest in Erye; and (iii) only 6% of the net profit will be
distributed to us directly for our operating expenses.  As a result,
we will not be able to supplement our cash flow fully from the operations and
income expected to be generated by Erye.
 
 We will need substantial additional
capital to continue operations and additional capital may not be available on
acceptable terms, or at all.
 
 We will require substantial additional
capital to fund our business plan, including additional research and development
activities related to our adult stem cell technologies and drug development
efforts, and to support marketing efforts in the U.S. and China. Our actual cash
requirements may differ materially from those currently
estimated.
 
 AtJune 30, 2010, we had a cash balance of $10.9
million.  The trading volume of our common stock, coupled with our
history of operating losses and liquidity problems, may make it difficult for us
to raise capital on acceptable terms or at all. The demand for the equity and
debt of small cap biopharmaceutical companies like ours is dependent upon many
factors, including the general state of the financial markets. As demonstrated
over the last year, during times of extreme market volatility, capital may not
be available on favorable terms, if at all. Our inability to obtain such
additional capital on acceptable terms could materially and adversely affect our
business operations and ability to continue as a going
concern.
  41
  We have a significant number of
securities convertible into, or allowing the purchase of our common stock.
Investors could be subject to increased dilution. Also, the issuance of
additional shares as a result of such conversion or purchase, or their
subsequent sale, could adversely affect the price of our common
stock.
 
 Investors in our company will be subject
to increased dilution upon conversion of our preferred stock and upon the
exercise of outstanding stock options and warrants.  There
were57,001,543shares
of our common stock outstanding as ofAugust 16, 2010.  As of that date, preferred
stock outstanding could be converted into 10,000 shares of our common stock and
stock options and warrants outstanding that are exercisable represented an
additional30,720,242shares of our common stock that could be issued in the future.  Most
of the outstanding shares of our common stock, as well as the vast majority of
the shares of our common stock that may be issued under our outstanding options
and warrants, are not restricted from trading or have the contractual right to
be registered.
 
 Any significant increase in the number
of shares offered for sale could cause the supply of our common stock available
for purchase in the market to exceed the purchase demand for our common stock.
Such supply in excess of demand could cause the market price of our common stock
to decline.
 
 Actual and beneficial ownership of large
quantities of our common stock by our executive officers, directors, and other
substantial stockholders, may substantially reduce the influence of other
stockholders.
 
 As ofAugust 16, 2010, our executive officers, directors, and
5%-or-more stockholders collectively beneficially
owned45,430,148shares of our common stock.  These beneficial holdings
represent64.9%of our
common stock on a fully-diluted basis. As a result, such persons may have the
ability to exercise enhanced control over the approval process for actions that
require stockholder approval, including: the election of our directors and the
approval of mergers, sales of assets or other significant corporate transactions
or other matters submitted for stockholder approval. Because of the beneficial
ownership position of these persons and entities, other stockholders may have
less influence over matters submitted for stockholder approval. Furthermore, at
certain times the interests of our substantial stockholders may conflict with
the interests of our other stockholders.
 
 Some of our directors and officers have
positions of responsibility with other entities, and therefore have loyalties
and fiduciary obligations to both our company and such other entities. These
dual positions subject such persons to conflicts of interest in related party
transactions which may cause such related party transactions to have
consequences to  our company that are less favorable than those which
our Company could have attained in comparable transactions with unaffiliated
entities.
 
 Eric H.C. Wei, a member of our Board of
Directors, is also the Managing Partner of RimAsia Capital Partners, L.P., or
RimAsia. RimAsia, a substantial stockholder of our company, beneficially owns43.3% of our common stock
as ofAugust 16, 2010. Shi
Mingsheng (who became a director of our company in March 2010) and Madam Zhang
Jian (the General Manager of Erye and the Company’s Vice President of
Pharmaceutical Operations), together with certain other persons, have shared
voting and dispositive power over the shares of our common stock held by
Fullbright Finance Limited, or Fullbright. Fullbright is a substantial
stockholder of our company, beneficially owning8.3% of our common stock as ofAugust 16, 2010. These
relationships create, or, at a minimum, appear to create potential conflicts of
interest when members of our company’s senior management are faced with
decisions that could have different implications for our company and the other
entities with which our directors or officers are
associated.
 
 Although the Company has established
procedures designed to ensure that material related party transactions are fair
to the Company, no assurance can be given as to how potentially conflicted board
members or officers will evaluate their fiduciary duties to the Company and to
other entities that they may owe fiduciary duties, respectively, or how such
individuals will act in such circumstances. Furthermore, the appearance of
conflicts, even if such conflicts ultimately do not harm the Company, might
adversely affect the public’s perception of our business, as well as its
relationship with its existing customers, licensors, licensees and service
providers and its ability to enter into new relationships in the
future.
 
 Erye’s
success is dependent upon its ability to establish and maintain its intellectual
property rights.
 
 In the
PRC, there has been substantial litigation in the pharmaceutical industry with
respect to the manufacturing, use and sale of new products. These lawsuits
relate to the validity and infringement of patents or proprietary rights of
third parties. Erye has been and in the future may be required to commence or
defend against charges relating to the infringement of patent or proprietary
rights. Any such litigation could: (i) require Erye to incur substantial
expense, even if it is insured or successful in the litigation; (ii) require
Erye to divert significant time and effort of its technical and management
personnel; (iii) result in the loss of its rights to develop or make certain
products; and (iv) require Erye to pay substantial monetary damages or royalties
in order to license proprietary rights from third parties.   Erye
recently was a party to a patent and copyright infringement dispute with respect
to a particular antibiotics complex it manufactured (representing less than 2%
of Erye’s sales in 2009), as a result of which a judgment was rendered against
Erye in the approximate amount of  5 million RMB (approximately $750,000)
and enjoining it from manufacturing, marketing and selling this product. Erye is
appealing the judgment and is also engaged in settlement
negotiations.  See Note 13, Commitments and Contingencies, to the
unaudited financial statements.
 
 42
 
 Erye's
production will be concentrated in two production lines and Erye will be
operating in a new facility.
 
 Erye
recently passed the government inspection by the State Food and Drug
Administration (“SFDA”) in China to manufacture penicillin powder for injection
and cephalosporin powder for injection at its new manufacturing facility which
provides 50% greater manufacturing capacity than its existing
plant.  The two production lines recently approved accounted for over
70% of Erye's product sales in 2009.  More recently, these two
production lines became fully operational.  These production lines, coupled
with the approval of the lines earlier in 2010 for solvent crystallization
sterile penicillin and freeze dried raw sterile penicillin, is allowing Erye to
relocate  over 90% of its 2009 sales to the new
facility.  Any interruptions in production with respect to those lines
once they are operational at the new facility will have a material adverse
effect on Erye's business and ours.  There are inherent problems in
commencing operations at any new production facility.  If Erye
encounters operational difficulties in commencing production at its new
facility, it could have a material adverse effect on Erye's business and
ours.
 
 Fluctuations
in the value of the Renminbi relative to the U.S. dollar could affect our
operating results.
 
 We
prepare our financial statements in U.S. dollars, while our underlying
businesses operate in two currencies, U.S. dollars and Chinese Renminbi. It is
anticipated that our Chinese operations will conduct their operations primarily
in Renminbi and our U.S. operations will conduct their operations in dollars. At
the present time we do not expect to have significant cross currency
transactions that will be at risk to foreign currency exchange rates.
Nevertheless, the conversion of financial information using a functional
currency of Renminbi will be subject to risks related to foreign currency
exchange rate fluctuations. The value of Renminbi against the U.S. dollar and
other currencies may fluctuate and is affected by, among other things, changes
in China’s political and economic conditions and supply and demand in local
markets. As we have significant operations in China, and will rely principally
on revenues earned in China, any significant revaluation of the Renminbi could
materially and adversely affect our financial results. For example, to the
extent that we need to convert U.S. dollars we receive from an offering of our
securities into Renminbi for our operations, appreciation of the Renminbi
against the U.S. dollar could have a material adverse effect on our business,
financial condition and results of operations.
 
 Beginning
in July of 2005, the PRC government changed its policy of pegging the value of
Renminbi to the U.S. dollar. Under the new policy, the value of the Renminbi has
fluctuated within a narrow and managed band against a basket of certain foreign
currencies. 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. There can be
no assurance that Renminbi will be stable against the U.S. dollar.  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.
  ITEM 2.  UNREGISTERED SALES OF
EQUITY SECURITIES AND USE OF PROCEEDS
 
 Effective
May 26, 2010, the Company issued 25,000 shares of restricted common stock to an
investor pursuant to the exercise of a warrant issued in a private placement of
securities by the Company in May 2008.  The exercise price was $1.75
per share, resulting in proceeds to the Company of $43,750.
 
 Effective
June 1, 2010, the Company issued 400,000 shares of restricted common stock to
Fullbright Finance Limited (“Fullbright”), pursuant to the exercise of a warrant
issued to Fullbright in a private placement of securities by the Company in
November 2008.  The exercise price was $1.75 per share, resulting in
proceeds to the Company totaling $700,000.
 
 Effective
as of June 18, 2010, the Company issued to a law firm providing legal services
to the Company with respect to obtaining funding from various agencies of the
State of New Jersey and Federal Government among other things, a five year
warrant to purchase 25,000 shares of restricted common stock at a per share
exercise price of $2.52, vesting in its entirety on December 31,
2010.
 
 Effective
as of June 29, 2010, the Company entered into an agreement with a consultant to
act as a special strategic advisor from June 29, 2010 through September 30,
2010.  In consideration for providing services under this agreement,
in addition to certain specified cash consideration, the Company agreed to issue
to the consultant 50,000 shares of restricted common stock, to vest in their
entirety on September 30, 2010; and a five year warrant to purchase 50,000
shares of restricted common stock at a per share exercise price equal to $1.82,
vesting in its entirety on September 30, 2010.
 
 Effective
as of June 30, 2010, the Company issued warrants to Rodman & Renshaw, LLC to
purchase up to 93,023 shares of restricted common stock at a per share exercise
price of $2.6875 (with certain rights of cashless exercise) expiring May 10,
2015.   These warrants were issued pursuant to the terms of a
June 24, 2010 placement agent agreement under which Rodman & Renshaw, LLC
acted as placement agent and  whereby the Company completed a
registered direct transaction under a registration statement filed with the SEC
which closed on June 30, 2010 and in which the Company sold 2,325,582 units at a
purchase price of $2.15 per unit (for aggregate gross proceeds of $5
million).  The warrants issued to the placement agent were not covered
by the registration statement.
  43
  The offer
and sale by the Company of the securities described above were made in reliance
upon the exemption from registration provided by Section 4(2) of the Securities
Act of 1933, as amended (the “Securities Act”), for transactions by an issuer
not involving a public offering.  The offer and sale of such
securities were made without general solicitation or advertising to “accredited
investors” as such term is defined in Rule 501(a) of Regulation D promulgated
under the Securities Act.
 
 ITEM 3.  DEFAULTS UPON SENIOR
SECURITIES
 
 None
 
 ITEM 4.  REMOVED AND
RESERVED
 
 ITEM 5. OTHER
INFORMATION
 
 None
 
 ITEM
6.  EXHIBITS
 
 (a)           Exhibits
 
 Exhibit
              Description
              Reference1(a)
              Placement
      Agent Agreement, dated June 24, 2010, between NeoStem, Inc. and Rodman
      & Renshaw, LLC (1)
              1.14(a)
              Form
      of Common Stock Purchase Warrant for June 2010 (1)
              4.14(b)
              Form
      of Placement Agent Warrant for June 2010 (1)
              4.210(a)
              Form
      of Securities Purchase Agreement dated June 25, 2010 (1)
              10.110(b)
              Common
      Stock Purchase Agreement, dated as of May 19, 2010, by and between
      NeoStem, Inc. and Commerce Court Small Cap Value Fund, Ltd.
      (2)
              10.110(c)
              Amendment
      No. 2 dated April 29, 2010 to Exclusive License Agreement dated November
      12, 2007 between Stem Cell Technologies, Inc. and the University of
      Louisville Research Foundation, Inc.*
              10.110(d)
              English
      translations of Supplemental Lease Agreement (Assignment) dated as of
      February 20, 2010 among NeoStem (China), Inc., Qingdao Niao Bio-Technology
      Company and Beijing Zhongguancun Life Science Park Development Co., Ltd.
      and related House Lease Agreement dated May 12, 2009 between Qingdao Niao
      Bio-Technology Company and Beijing Zhongguancun Life Science Park
      Development Co., Ltd.*
              10.210(e)
              Confidentiality
      Agreement dated as of April 30, 2010 between NeoStem, Inc. and Enhance
      BioMedical Holdings Limited*
              10.310(f)
              Consulting
      Agreement dated as of May 11, 2010 between NeoStem, Inc. and RimAsia
      Capital Partners, LP*
              10.410(g)
              Form
      of Stock Option Grant Agreement under NeoStem, Inc. 2009 Equity
      Compensation Plan *
              10.510(h)
              Form
      of Grant Agreement under NeoStem, Inc. 2009 Non-U.S. Based Equity
      Compensation Plan*
              10.610(i)
              Amendment
      No. 1 dated June 9, 2010 to Employment Agreement dated August 17, 2009
      between NeoStem, Inc. and Anthony Salerno(3)
              10.110(j)
              Offer
      Letter dated June 9, 2010 between NeoStem, Inc. and Madam Zhang
      Jian(3)
              10.231.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.*
              31.131.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.*
              31.232.1
              Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.**
              32.132.2
              Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.**
              32.2(1)
              Filed
      with the Securities and Exchange Commission on June 28, 2010 as an
      exhibit, numbered as indicated above, to our Current Report on Form 8-K
      dated June 25, 2010, which exhibit is incorporated here by
      reference(2)
              Filed
      with the Securities and Exchange Commission on May 19, 2010 as an exhibit,
      numbered as indicated above, to our Current Report on Form 8-K dated May
      19, 2010, which exhibit is incorporated here by reference(3)
              Filed
      with the Securities and Exchange Commission on June 11, 2010 as an
      exhibit, numbered as indicated above, to our Current Report on Form 8-K
      dated June 9, 2010, which exhibit is incorporated here by
      reference*
              Filed
      herewith**
              Furnished
      herewith
  44
  SIGNATURES
 
 Pursuant to the requirements of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.
 
 NEOSTEM, INC.
      (Registrant)By:
              /s/ Robin Smith
      M.D.Robin Smith M.D., Chief Executive
      OfficerDate:August 16,
      2010
 
 
 By:
              /s/ Larry A.
      MayLarry A. May, Chief Financial
      OfficerDate:August 16,
      2010
  By:
              /s/ Christopher C.
      DuignanChristopher C. Duignan,
      Chief Accounting OfficerDate:August 16,
      2010
  45