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 ENDED September 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. Yesx          Noo





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


Yes    o        Noo





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 filer   o     (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).


Yes  o     No  x


57,614,858SHARES, $.001 PAR
VALUE, AS OF November 11, 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 At September 30, 2010 and December 31,
      2009
                3Consolidated
      Statements of Operations for the three and nine months ended
      September 30, 2010 and 2009
                4Consolidated
      Statements of Cash Flows for the nine months ended September 30, 2010
      and 2009
                5Notes
      to Unaudited Consolidated Financial Statements
                6Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                31Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                43Item
      4.
                Controls
      and Procedures
                43Part
      II - Other Information:Item
      1.
                Legal
      Proceedings
                46Item
      1A.
                Risk
      Factors
                46Item
      2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                48Item
      3.
                Defaults
      Upon Senior Securities
                48Item
      4.
                Removed
      and Reserved
                48Item
      5.
                Other
      Information
                48Item
      6.
                Exhibits
                48Signatures
                49




2





PART
I. FINANCIAL INFORMATION





Item
1. Consolidated Financial Statements





NEOSTEM,
INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


(Unaudited)





September 30,
                
                
                December 31,2010
                
                
                2009ASSETSCurrent
      AssetsCash
      and cash equivalents
                
                $
                4,066,693
                
                
                $
                7,159,369Short
      term investments
                
                
                257,415
                
                
                
                287,333Restricted
      cash
                
                
                3,321,610
                
                
                
                4,714,610Accounts receivable trade, less
      allowance for doubtful accounts of $295,215 and $273,600,
      respectively
                
                
                4,522,304
                
                
                
                5,725,241Inventories
                
                
                14,670,611
                
                
                
                12,979,008Prepaids
      and other current assets
                
                
                1,419,234
                
                
                
                933,657Total
      current assets
                
                
                28,257,867
                
                
                
                31,799,218Property,
      plant and equipment, net
                
                
                33,208,054
                
                
                
                21,271,405Land
      use rights, net
                
                
                4,718,154
                
                
                
                4,698,567Goodwill
                
                
                35,115,954
                
                
                
                34,425,728Intangible
      assets, netLease
      rights, net
                
                
                381,751
                
                
                
                633,136Customer
      list, net
                
                
                14,213,311
                
                
                
                15,079,567Other
      intangible assets, net
                
                
                708,171
                
                
                
                747,288Total
      intangible assets, net
                
                
                15,303,233
                
                
                
                16,459,991Other
      assets
                
                
                367,266
                
                
                
                238,941$
                116,970,528
                
                
                $
                108,893,850LIABILITIES
      AND EQUITYCurrent
      liabilitiesAccounts
      payable
                
                $
                7,622,209
                
                
                $
                8,263,718Accrued
      liabilities
                
                
                4,709,170
                
                
                
                2,965,525Bank
      loans
                
                
                -
                
                
                
                2,197,500Notes
      payable
                
                
                6,544,682
                
                
                
                9,793,712Unearned
      revenues
                
                
                1,694,081
                
                
                
                2,048,400Total
      current liabilities
                
                
                20,570,142
                
                
                
                25,268,855Long-term
      liabilitiesDeferred
      tax liability
                
                
                4,345,940
                
                
                
                4,440,748Deferred
      rent liability
                
                
                49,513
                
                
                
                -Unearned
      revenues
                
                
                217,510
                
                
                
                224,705Amount
      due related party
                
                
                8,074,049
                
                
                
                7,234,291COMMITMENTS
      AND CONTINGENCIESConvertible
      Redeemable Series C Preferred stock; 8,177,512 shares designated,
      liquidation value $12.50 per share;8,177,512 shares
      issued and outstanding at December 31, 2009
                
                
                -
                
                
                
                13,720,048EQUITYShareholders'
      EquityPreferred
      stock; authorized, 20,000,000 shares
                
                
                -
                
                
                
                -Series B convertible redeemable
      preferred stock liquidation value, 1 share of
      common stock, $.01 par value; 825,000 shares designated; issued and
      outstanding, 10,000 shares at September 30, 2010 and December 31,
      2009
                
                
                100
                
                
                
                100Common stock, $.001 par value,
      authorized 500,000,000 shares; issued and outstanding,
      57,613,794 at September 30, 2010 and 37,193,491 shares at December
      31, 2009
                
                
                57,613
                
                
                
                37,193Additional
      paid-in capital
                
                
                132,974,293
                
                
                
                95,709,491Accumulated
      deficit
                
                
                (88,978,685
                )
                
                
                (71,699,191
                )Accumulated
      other comprehensive income (loss)
                
                
                1,583,208
                
                
                
                (67,917
                )Total
      shareholders' equity
                
                
                45,636,529
                
                
                
                23,979,676Noncontrolling
      interests
                
                
                38,076,845
                
                
                
                34,025,527Total
      equity
                
                
                83,713,374
                
                
                
                58,005,203$
                116,970,528
                
                
                $
                108,893,850





See
accompanying notes to consolidated financial statements.


3





NEOSTEM,
INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)





Three Months Ended September 30,
                              
                              
                              Nine Months Ended September 30,2010
                              
                              
                              2009
                              
                              
                              2010
                              
                              
                              2009Revenues
                              
                              $
                              16,475,558
                              
                              
                              $
                              85,067
                              
                              
                              $
                              51,716,260
                              
                              
                              $
                              157,709Cost
      of revenues
                              
                              
                              11,232,819
                              
                              
                              
                              53,121
                              
                              
                              
                              35,015,540
                              
                              
                              
                              92,940Gross
      profit
                              
                              
                              5,242,739
                              
                              
                              
                              31,946
                              
                              
                              
                              16,700,720
                              
                              
                              
                              64,769Research
      and development
                              
                              
                              1,679,945
                              
                              
                              
                              1,829,775
                              
                              
                              
                              5,113,487
                              
                              
                              
                              2,599,667Selling,
      general, and administrative
                              
                              
                              9,306,622
                              
                              
                              
                              5,433,468
                              
                              
                              
                              23,442,282
                              
                              
                              
                              11,209,772Operating
      loss
                              
                              
                              (5,743,828
                              )
                              
                              
                              (7,231,297
                              )
                              
                              
                              (11,855,049
                              )
                              
                              
                              (13,744,670
                              )Other
      income (expense):Other
      income (expense), net
                              
                              
                              45,829
                              
                              
                              
                              13,123
                              
                              
                              
                              31,326
                              
                              
                              
                              25,816Interest
      expense
                              
                              
                              (10,663
                              )
                              
                              
                              (1,038
                              )
                              
                              
                              (25,380
                              )
                              
                              
                              (58,966
                              )35,166
                              
                              
                              
                              12,085
                              
                              
                              
                              5,946
                              
                              
                              
                              (33,150
                              )Loss
      from operations before provision for  income taxes and
      noncontrolling interests
                              
                              
                              (5,708,662
                              )
                              
                              
                              (7,219,212
                              )
                              
                              
                              (11,849,103
                              )
                              
                              
                              (13,777,820
                              )Provision
      for income taxes
                              
                              
                              285,976
                              
                              
                              
                              -
                              
                              
                              
                              1,191,179
                              
                              
                              
                              -Net
      loss
                              
                              
                              (5,994,638
                              )
                              
                              
                              (7,219,212
                              )
                              
                              
                              (13,040,282
                              )
                              
                              
                              (13,777,820
                              )Less
      - net income attributable to noncontrolling
      interests
                              
                              
                              1,145,588
                              
                              
                              
                              -
                              
                              
                              
                              4,085,743
                              
                              
                              
                              -Net
      loss attributable to controlling interests
                              
                              
                              (7,140,226
                              )
                              
                              
                              (7,219,212
                              )
                              
                              
                              (17,126,025
                              )
                              
                              
                              (13,777,820
                              )Preferred
      dividends
                              
                              
                              -
                              
                              
                              
                              404,141
                              
                              
                              
                              153,469
                              
                              
                              
                              655,868Net
      loss attributable to common shareholders
                              
                              $
                              (7,140,226
                              )
                              
                              $
                              (7,623,353
                              )
                              
                              $
                              (17,279,494
                              )
                              
                              $
                              (14,433,688
                              )Basic
      and diluted loss per share
                              
                              $
                              (0.13
                              )
                              
                              $
                              (0.90
                              )
                              
                              $
                              (0.36
                              )
                              
                              $
                              (1.78
                              )Weighted
      average common shares outstanding
                              
                              
                              56,777,430
                              
                              
                              
                              8,511,150
                              
                              
                              
                              48,599,359
                              
                              
                              
                              8,096,469





See
accompanying notes to consolidated financial statements.


4





NEOSTEM,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)


For the Nine Months EndedSeptember 30,2010
                        
                        
                        2009Cash
      flows from operating activities:Net
      Loss
                        
                        $
                        (13,040,282
                        )
                        
                        $
                        (13,777,820
                        )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Common
      stock, stock options and warrants issued as payment for compensation, and
      services rendered
                        
                        
                        7,399,842
                        
                        
                        
                        3,832,116Depreciation
      and amortization
                        
                        
                        2,556,994
                        
                        
                        
                        96,506Loss
      on short-term investments
                        
                        
                        7,215
                        
                        
                        
                        -Bad
      debt expense
                        
                        
                        16,311
                        
                        
                        
                        -Deferred
      tax liability
                        
                        
                        (182,417
                        )
                        
                        
                        -Changes
      in operating assets and liabilities:Prepaid
      expenses and other current assets
                        
                        
                        (461,743
                        )
                        
                        
                        (436,831
                        )Accounts
      receivable
                        
                        
                        1,278,573
                        
                        
                        
                        (156,464
                        )Inventory
                        
                        
                        (1,405,838
                        )
                        
                        
                        -Unearned
      revenues
                        
                        
                        (392,040
                        )
                        
                        
                        189,179Other
      assets
                        
                        
                        (128,225
                        )
                        
                        
                        -Accounts
      payable, accrued expenses and other current liabilities
                        
                        
                        1,175,902
                        
                        
                        
                        741,443Net
      cash used in operating activities
                        
                        
                        (3,175,708
                        )
                        
                        
                        (9,511,871
                        )Cash
      flows from investing activities:Investment
      in short-term investments
                        
                        
                        (2,424,132
                        )
                        
                        
                        -Proceeds
      from short-term investments
                        
                        
                        2,452,015
                        
                        
                        
                        -Cash
      restricted as collateral for bank loans
                        
                        
                        1,463,710
                        
                        
                        
                        (180,327
                        )Acquisition
      of property and equipment
                        
                        
                        (12,510,648
                        )
                        
                        
                        (690,981
                        )Net
      cash used in investing activities
                        
                        
                        (11,019,055
                        )
                        
                        
                        (871,308
                        )Cash
      flows from financing activities:Net
      proceeds from the issuance of convertible redeemable preferred stock and
      warrants
                        
                        
                        -
                        
                        
                        
                        15,669,220Net
      proceeds from the exercise of warrants and options
                        
                        
                        3,101,850
                        
                        
                        
                        -Net
      proceeds from issuance of capital stock
                        
                        
                        13,138,948
                        
                        
                        
                        -Proceeds
      from related party
                        
                        
                        566,775
                        
                        
                        
                        -Repayment
      of bank loans
                        
                        
                        (2,203,650
                        )
                        
                        
                        -Proceeds
      from notes payable
                        
                        
                        13,256,799
                        
                        
                        
                        1,431,453Repayment
      of notes payable
                        
                        
                        (16,644,465
                        )
                        
                        
                        (1,284,753
                        )Payment
      of dividend
                        
                        
                        (222,924
                        )
                        
                        
                        -Payment
      of capitalized lease obligations
                        
                        
                        -
                        
                        
                        
                        (14,726
                        )Net
      cash provided by financing activities
                        
                        
                        10,993,333
                        
                        
                        
                        15,801,194Effect
      of currency exchange rate change
                        
                        
                        108,754
                        
                        
                        
                        -Net
      increase (decrease) in cash and cash equivalents
                        
                        
                        (3,092,676
                        )
                        
                        
                        5,418,015Cash
      and cash equivalents at beginning of period
                        
                        
                        7,159,369
                        
                        
                        
                        430,786Cash
      and cash equivalents at end of period
                        
                        $
                        4,066,693
                        
                        
                        $
                        5,848,801Supplemental
      Disclosure of Cash Flow Information:Cash
      paid during the period for:Interest
                        
                        $
                        219,376
                        
                        
                        $
                        17,823Taxes
                        
                        
                        1,784,325
                        
                        
                        
                        -Supplemental
      Schedule of non-cash investing activitiesAcquisition
      of property and equipment
                        
                        
                        348,488
                        
                        
                        
                        -Capitalized
      interest
                        
                        
                        307,200
                        
                        
                        
                        -Supplemental
      Schedule of non-cash financing activitiesFinancing
      costs for capital stock raises
                        
                        
                        75,466
                        
                        
                        
                        -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 are 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
in the Southern California and Northeast markets and during 2010 we have been
entering into new agreements for collection centers with the goal of expanding
our 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,
copyrights 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
addition to the Company’s services, the Company is conducting research and
development activities on its own at its laboratory facility in Cambridge,
Massachusetts and through collaborations in pursuit of diagnostic and
therapeutic applications using autologous adult stem cells, including
applications using its VSELTM
Technology, with regard to very small embryonic-like stem cells, which it
licenses from the University of Louisville.




In 2009,
the Company began several China-based, adult stem cell initiatives including:
(i) creating a separate China-based stem cell 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 began offering stem cell banking services and certain stem
cell therapies to patients in Asia, as well as to foreigners traveling to Asia
seeking medical treatments that are either unavailable or cost prohibitive in
their home countries.  In the third quarter of 2010, Weihai Municipal
Price Bureau, the local authority in charge of pricing for public medical
services in China,  approved the pricing for single side and bilateral
arthroscopic orthopedic autologous adult stem cell based treatment licensed by
the Company which is being administered at Wendeng Orthopedic Hospital
based in Wendeng, Shandong Province, China, and Weihai Municipal Labor Bureau
Medical Insurance Office approved Wendeng Hospital's application for
reimbursement whereby patients are eligible to receive reimbursement for up to
80% of the cost of the orthopedic procedure under the new technology
category.


6





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 (“CBH Merger Sub”), a wholly-owned subsidiary of NeoStem, with Merger
Sub as the surviving entity (the “Erye Merger”). As a result of the Erye 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.





On
September 16, 2010, the Board of Directors of NeoStem and on September 22, 2010
the Board of Managers of Progenitor Cell Therapy, LLC, a Delaware limited
liability company (“PCT”), unanimously approved the merger (the “PCT Merger”) of
NBS Acquisition Company, LLC, a newly formed wholly-owned subsidiary of NeoStem
(“Subco”), with and into PCT pursuant to an Agreement and Plan of Merger, dated
September 23, 2010 (as such agreement may be amended from time to time, the
“PCT Agreement and Plan of Merger”), among NeoStem, PCT and
Subco.  PCT is an internationally recognized cell therapy services and
development company that, through its cell therapy manufacturing facilities and
team of professionals, facilitates the preclinical and clinical development and
eventual commercialization of cellular therapies for clients in the United
States and internationally. To its clients, PCT offers current Good
Manufacturing Practices (cGMP)-compliant cell transportation, manufacturing,
storage and distribution services and supporting clinical trial design, process
development, logistics, and regulatory and quality systems development
services.  PCT serves the developing cell therapy industry, including
biotechnology, pharmaceutical and medical products companies, health care
providers, and academic investigators, from licensed, state-of-the-art cell
therapy manufacturing facilities in Allendale, New Jersey and Mountain View,
California. PCT supports the research of leading academic investigators designed
to expedite the broad clinical application of cell therapy.





Pursuant
to the terms of the PCT Agreement and Plan of Merger, all of the membership
interests of PCT outstanding immediately prior to the effective time of the PCT
Merger (the “Effective Time”) will be converted into the right to receive, in
the aggregate, 11,200,000 shares of the common stock, par value $0.001 per
share, of NeoStem (the “NeoStem Common Stock” or the “Parent Common Stock”) and,
subject to the satisfaction of certain conditions, warrants to purchase a
minimum of 1,000,000 shares and a maximum of  3,000,000 shares of
NeoStem Common Stock, as follows:





(i)
            common
      stock purchase warrants to purchase one million (1,000,000) shares of
      Parent Common Stock exercisable over a seven year period at an exercise
      price of $7.00 per share (the “$7.00 Warrants”), and which will vest only
      if a specified business milestone is accomplished within three (3) years
      of the closing date of the PCT Merger;
and


(ii)
            common
      stock purchase warrants to purchase one million (1,000,000) shares of
      Parent Common Stock exercisable over a seven year term at an exercise
      price of $3.00 per share (the “$3.00 Warrants”), if the volume weighted
      average of the closing prices of sales of Parent Common Stock on the
      NYSE-Amex for the  three (3) trading days ending on the trading
      day that is two (2) days prior to the closing date of the PCT Merger (the
      “Parent Per Share Value”) is less than $2.50;
  and


(iii)
            common
      stock purchase warrants to purchase one million (1,000,000) shares of
      Parent Common Stock exercisable over a seven year period at an exercise
      price of $5.00 per share (the “$5.00 Warrants”) and, collectively with the
      $7.00 Warrants and the $3.00 Warrants (the “Warrants”), if the Parent Per
      Share Value is less than $1.70.





The
shares of Parent Common Stock issuable in the PCT Merger are subject to
adjustment, provided that in no event will NeoStem be required to issue more
than 11,200,000 shares of NeoStem Common Stock.





Note
2 – Summary of Significant Accounting Policies


Principles of Consolidation:
The consolidated financial statements include the accounts of NeoStem, Inc. 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. (CBH)
                            
                            100%
                            
                            
                            United
      States of AmericaSuzhou
      Erye Pharmaceuticals Company Ltd.
                            
                            51%
      owned by CBH
                            
                            
                            People’s
      Republic of
China




7





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





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





Certain
reclassifications have been made to prior year amounts to conform to the current
year presentation.  In particular, at December 31, 2009, the Company
reclassified short term investments of $287,300 from Prepaid and other current
assets to Short term investments, unearned revenues in excess of one year of
$224,700 from Current liabilities to Long-term liabilities. In
addition, for the Statement of Cash Flows for the nine months ended September
30, 2009 the Company revised its presentation of the reconciliation of cash
flows from operating activities to reconcile such cash flows from Net loss
attributable to common shareholders to Net Loss.  Lastly,
the company reclassed the 2009 amount related to Cash restricted as collateral
for bank loans from financing activities to investing
activities.




In
reviewing share-based payment expense to both employees and non-employees, the
Company recorded an adjustment in the three months ended September 30, 2010 of
approximately $920,000 to reduce share-based payment expense for amounts
previously recognized in the prior quarters of 2010 and in the year ended
December 31, 2009.




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





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





Concentration of Risks: For
the three and nine months ended September 30, 2010, two major suppliers provided
approximately 16.5% and 19.7%, respectively, of Erye’s purchases of raw
materials with each supplier individually accounting for approximately
8.8%  and 7.7%, and 11.7%  and
8.0%,  respectively. As of September 30, 2010, the total accounts
payable to the two major suppliers was 19.6% of the total accounts payable
balance.





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.


8





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
two of the eight 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.  Any interruption or cessation in production could
impact market sales.





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 accounts. 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):





September 30,
                  
                  
                  December 31,2010
                  
                  
                  2009Raw
      materials
                  
                  $
                  5,178.8
                  
                  
                  $
                  6,338.8Work
      in process
                  
                  
                  2,844.7
                  
                  
                  
                  666.7Finished
      goods
                  
                  
                  6,647.1
                  
                  
                  
                  5,973.5Total
      inventory
                  
                  $
                  14,670.6
                  
                  
                  $
                  12,979.0





Property, Plant, 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.





Property,
plant, and equipment consisted of the following (in thousands):





September 30,
                    
                    
                    December 31,2010
                    
                    
                    2009Building
      and improvements
                    
                    $
                    1,644.0
                    
                    
                    $
                    -Machinery
      and equipment
                    
                    
                    23,890.7
                    
                    
                    
                    3,289.3Lab
      equipment
                    
                    
                    699.8
                    
                    
                    
                    704.2Furniture
      and fixtures
                    
                    
                    301.1
                    
                    
                    
                    273.2Vehicles
                    
                    
                    269.8
                    
                    
                    
                    75.3Software
                    
                    
                    91.9
                    
                    
                    
                    81.7Leasehold
      improvements
                    
                    
                    64.9
                    
                    
                    
                    58.4Construction
      in progress
                    
                    
                    7,640.5
                    
                    
                    
                    17,075.134,602.7
                    
                    
                    
                    21,557.2Accumulated
      depreciation
                    
                    
                    (1,394.6
                    )
                    
                    
                    (285.8
                    )Total
      property, plant, and equipment
                    
                    $
                    33,208.1
                    
                    
                    $
                    21,271.4




9





The
Company’s results included depreciation expense of approximately $581,818 and
$27,692 for the three months ended September 30, 2010 and 2009, respectively,
and $1,058,718 and $70,099 for the nine months ended September 30, 2010 and
2009, respectively.





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 which 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 $7.5
million.  No depreciation is provided for construction-in-progress
until such time the assets are completed and placed into service. Interest
incurred during the period of construction, if material, is
capitalized.





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 the Company’s financial statements or
tax returns. The Company continues to evaluate the accounting for uncertainty in
tax positions.  The guidance requires companies to recognize in their
financial statements the impact of a tax position if the position is more likely
than not of being sustained on audit. The position ascertained inherently
requires judgment and estimates by management.  For the three and nine
months ended September 30, 2010 and 2009, management does not believe the
Company has any material uncertain tax positions that would require it to
measure and reflect the potential lack of sustainability of a position on audit
in its financial statements. The Company will continue to evaluate its uncertain
tax positions in future periods to determine if measurement and recognition in
its financial statements is necessary.  The Company does not believe
there will be any material changes in its unrecognized tax positions over the
next 12 months.





Comprehensive Income (Loss):The accumulated other comprehensive income (loss) balance at September
30, 2010 and December 31, 2009 in the amount of $1,583,200 and $(67,900),
respectively, is comprised entirely of cumulative gains and losses resulting
from foreign currency translation.  Comprehensive loss for the three
and nine months ended September 30, 2010 and 2009 was as follows (in
thousands):





Three Months Ended September 30,
                
                
                Nine Months Ended September 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Net
      loss
                
                $
                (5,994.6
                )
                
                $
                (7,219.2
                )
                
                $
                (13,040.3
                )
                
                $
                (13,777.8
                )Other
      comprehensive income (loss)Foreign
      currency translation
                
                
                1,483.4
                
                
                
                (7.5
                )
                
                
                1,651.1
                
                
                
                (7.6
                )Total
      other comprehensive income (loss)
                
                
                1,483.4
                
                
                
                (7.5
                )
                
                
                1,651.1
                
                
                
                (7.6
                )Comprehensive
      loss
                
                
                (4,511.2
                )
                
                
                (7,226.7
                )
                
                
                (11,389.2
                )
                
                
                (13,785.4
                )Comprehensive
      income attributable to non controlling interests
                
                
                1,864.0
                
                
                
                -
                
                
                
                4,877.8
                
                
                
                -Comprehensive
      loss attributable to common shareholders
                
                $
                (6,375.3
                )
                
                $
                (7,226.7
                )
                
                $
                (16,267.0
                )
                
                $
                (13,785.4
                )





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.




Intangible Assets: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, consist of patents and rights associated
primarily with the VSELTM Technology, patent rights owned by
Erye, a lease right between Erye and its 49% shareholder, and Eyre’s customer list.
These intangible assets are amortized on a straight line basis over their
respective lives. See Note 5.  10


Impairment of Long-lived
Assets:  The
Company reviews long-lived assets and certain identifiable
intangibles  for impairment 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
Compensation Expense:The Company records share-based payment expense at
fair value.  The Company utilizes the Black-Scholes valuation method
for determination of share-based compensation expense.  The Company
accounts for share-based compensation 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 compensation 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 per share is based on the weighted effect of all common shares issued and
outstanding, and is calculated by dividing net loss attributable to common
shareholders by the weighted average shares outstanding during the period.
Diluted loss per share, which is calculated by dividing net
loss attributable 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 the three and nine
months ended September 30, 2010 and 2009, the Company incurred net losses and
therefore no common stock equivalents were utilized in the calculation of
earnings per share. At September 30, 2010 and 2009, the Company excluded the
following potentially dilutive securities:





September 30, 2010
                  
                  
                  September 30, 2009Stock
      Options
                  
                  
                  13,558,214
                  
                  
                  
                  4,633,300Warrants
                  
                  
                  17,352,028
                  
                  
                  
                  18,196,780Series
      D Convertible Redeemable Preferred Stock
                  
                  
                  -
                  
                  
                  
                  12,932,510





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. 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 Ceregenex Corporation (see Note 12), which royalties are
recognized as revenue when they are received.


11


Revenues
for the three and nine months ended September 30, 2010 and 2009 were comprised
of the following (in thousands):





Three Months Ended September 30,
                  
                  
                  Nine Months Ended September 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009RevenuesPrescription
      drugs and intermediary pharmaceutical products
                  
                  $
                  16,378.1
                  
                  
                  $
                  -
                  
                  
                  $
                  51,500.6
                  
                  
                  $
                  -Stem
      cell revenues
                  
                  
                  62.0
                  
                  
                  
                  82.6
                  
                  
                  
                  128.4
                  
                  
                  
                  141.2Other
      revenues
                  
                  
                  35.5
                  
                  
                  
                  2.5
                  
                  
                  
                  87.3
                  
                  
                  
                  16.5$
                  16,475.6
                  
                  
                  $
                  85.1
                  
                  
                  $
                  51,716.3
                  
                  
                  $
                  157.7





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 affect the valuation of the fair value of
assets and liabilities and their placement within the fair value hierarchy
levels.





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





September 30, 2010Fair Value Measurements Using Fair Value HierarchyLevel 1
                  
                  
                  Level 2
                  
                  
                  Level 3Money
      Market Funds
                  
                  
                  -
                  
                  
                  $
                  1.0
                  
                  
                  
                  -Short
      term investments
                  
                  $
                  257.4
                  
                  
                  
                  -
                  
                  
                  
                  -





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 closing rate at the end of each reporting period. Cash flows are also
translated at average exchange 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.





Translation
adjustments resulting from this process are included in accumulated other
comprehensive income (loss) and amounted to $1,583,200 and $(67,900) as of
September 30, 2010 and December 31, 2009 respectively.


12


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.




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





The
general reserve is used to offset extraordinary losses. Subject to approval by
the relevant authorities, a subsidiary may, upon a resolution passed by the
shareholders, convert the general reserve into registered capital provided that
the remaining general reserve after the conversion shall be at least 25% of the
registered capital of the subsidiary before the capital increase as a result of
the conversion. The staff welfare and bonus reserve is used for the collective
welfare of the employees of the subsidiary. The enterprise expansion reserve is
for the expansion of the subsidiary’s operations and can also be converted to
registered capital upon a resolution passed by the shareholders subject to
approval by the relevant authorities. These reserves represent appropriations of
the retained earnings determined in accordance with Chinese law, and are not
distributable as cash dividends to the parent company, NeoStem. Statutory
reserves are $1,204,600 and $1,126,300 as of September 30, 2010 and December 31,
2009, respectively.





Relevant
PRC statutory laws and regulations permit payment of dividends by the Company’s
PRC subsidiaries only out of their accumulated earnings, if any, as determined
in accordance with PRC accounting standards and regulations. As a result of
these PRC laws and regulations, the Company’s PRC subsidiaries are restricted in
their ability to transfer a portion of their net assets either in the form of
dividends, loans or advances. The restricted amount was $211,100 at September
30, 2010, and $213,100 at December 31, 2009.





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 new guidance 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 the guidance and will continue evaluting the impact of this new
guidance on its consolidated financial statements.





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 materially, impact its consolidated financial
statements.


13


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.





Note
4 – Acquisitions


On
October 30, 2009, NeoStem consummated the Erye 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 Erye Merger, NeoStem acquired CBH’s 51%
ownership interest in Erye, a Sino-foreign joint venture with limited liability
organized under the laws of the PRC.  Erye specializes in the
production and sale 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 Erye Merger was
$34,904,300. 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 PRC, 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.


14


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





A
preliminary allocation of the consideration transferred to the net assets of
Erye was made as of the acquisition date. During the first nine months of 2010,
the Company adjusted the preliminary values assigned to certain assets and
liabilities in order to reflect additional information obtained since the Erye
Merger date. 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 in the fourth quarter 2010.
Under business combinations accounting guidance, the Company has up to one year
from the date of the Erye Merger to finalize the allocation of the consideration
transferred. A preliminary assessment of valuation work currently being
completed indicates that Goodwill could be decreased approximately $7 million to
$9.5 million with a corresponding increase in long lived and indefinite lived
intangible assets, net of an increase in deferred tax liabilities. Increases in
amortization of intangible assets is not expected to have a material impact on
the net loss reported for 2009 or the net loss reported for the nine months
ended September 30, 2010.





A
preliminary allocation of the consideration transferred to the net assets of CBH
was made as of the Erye Merger date. During the nine months ended September 30,
2010, the Company continued to review its preliminary allocation of the purchase
price associated with the Erye Merger and made the following retrospective
adjustments as of the Erye Merger date:





The
Company determined that finished goods inventory acquired in connection with the
Erye Merger was incorrectly valued and should have been increased by
approximately $1,917,000 to step-up such inventory to fair value at the Erye
Merger date.  Such finished goods inventory has been sold through
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 Erye 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 Erye
Merger date deferred tax liabilities of approximately $4,720,800 for such
book/tax basis differences.


15


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
                    )
                    
                    
                    21,271.4Goodwill
                    
                    
                    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
                    )Non
      controlling interests
                    
                    
                    34,786.8
                    
                    
                    
                    (761.3
                    )
                    
                    
                    34,025.5Total
      equity
                    
                    
                    59,586.9
                    
                    
                    
                    (1,581.6
                    )
                    
                    
                    58,005.3$
                    106,034.8
                    
                    
                    $
                    2,859.0
                    
                    
                    $
                    108,893.9


16





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
                        )
                        
                        
                        0.0
                        
                        
                        
                        (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 taxes
                        
                        
                        344.2
                        
                        
                        
                        (280.0
                        )
                        
                        
                        64.2Net
      loss
                        
                        
                        (24,183.9
                        )
                        
                        
                        (1,608.6
                        )
                        
                        
                        (26,092.9
                        )Less-net
      income (loss) 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
                )
                
                
                (820.4
                )
                
                
                (71,699.2
                )Accumulated
      other comprehensive loss
                
                
                (67.9
                )
                
                
                -
                
                
                
                (67.9
                )Non
      controlling interests
                
                
                34,786.8
                
                
                
                (788.2
                )
                
                
                33,998.6Total
      equity
                
                $
                59,586.9
                
                
                $
                (1,608.6
                )
                
                $
                57,978.3


17





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 inoperating
      activities:Common
      Stock, stock options and warrants issued as payment for compensation and
      services rendered
                                        
                                        
                                        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 in basis of inventory received at date
      of acquisition
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,917.0
                                        
                                        
                                        
                                        1,917.0Unearned
      revenuesDeferred
      acquisition costsChanges
      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 expenses
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -and
      other current liabilities
                                        
                                        
                                        1,274.7
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,274.7Net
      cash used in operating activities
                                        
                                        
                                        (8,648.0
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (8,648.0
                                        )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 loans
                                        
                                        
                                        2,197.5
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        2,197.5Cash
      restricted as collateral for bank loans
                                        
                                        
                                        (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


18


Presented
below is the unaudited proforma information as if the acquisition had occurred
at the beginning of the three and nine months ended September 30, 2009 along
with a comparison to the reported results for the three and nine ended September
30, 2010 (in thousands, except share and per share amounts):





(in $000 except for Per Share Data)
                            
                            Three Months Ended
                            
                            
                            Nine Months EndedSeptember 30, 2010
                            
                            
                            September 30, 2009
                            
                            
                            September 30, 2010
                            
                            
                            September 30, 2009(As
      Reported)
                            
                            
                            (Proforma)
                            
                            
                            (As
      Reported)
                            
                            
                            (Proforma)Revenues
                            
                            $
                            16,475.6
                            
                            
                            $
                            17,074.1
                            
                            
                            $
                            51,716.3
                            
                            
                            $
                            45,181.6Cost
      of revenues
                            
                            
                            11,232.9
                            
                            
                            
                            11,273.3
                            
                            
                            
                            35,015.5
                            
                            
                            
                            30,139.0Gross
      Profit
                            
                            
                            5,242.7
                            
                            
                            
                            5,800.8
                            
                            
                            
                            16,700.8
                            
                            
                            
                            15,042.6Research
      and development
                            
                            
                            1,679.9
                            
                            
                            
                            1,898.5
                            
                            
                            
                            5,113.5
                            
                            
                            
                            2,941.1Selling,
      general and administrative
                            
                            
                            9,306.6
                            
                            
                            
                            7,034.0
                            
                            
                            
                            23,442.3
                            
                            
                            
                            16,037.0Operating
      loss
                            
                            
                            (5,743.8
                            )
                            
                            
                            (3,131.7
                            )
                            
                            
                            (11,855.0
                            )
                            
                            
                            (3,935.5
                            )Other
      income (expense), net
                            
                            
                            35.2
                            
                            
                            
                            58.0
                            
                            
                            
                            5.9
                            
                            
                            
                            (14.7
                            )Loss
      from operations before provision for income taxes and noncontrolling
      interests
                            
                            
                            (5,708.6
                            )
                            
                            
                            (3,073.7
                            )
                            
                            
                            (11,849.1
                            )
                            
                            
                            (3,950.2
                            )Provision
      for taxes
                            
                            
                            286.0
                            
                            
                            
                            493.5
                            
                            
                            
                            1,191.2
                            
                            
                            
                            1,295.1Net
      loss
                            
                            
                            (5,994.6
                            )
                            
                            
                            (3,567.2
                            )
                            
                            
                            (13,040.3
                            )
                            
                            
                            (5,245.3
                            )Less-net
      income attributable to noncontrolling interests
                            
                            
                            1,145.6
                            
                            
                            
                            1,789.3
                            
                            
                            
                            4,085.7
                            
                            
                            
                            4,188.2Preferred
      dividends
                            
                            
                            -
                            
                            
                            
                            404.1
                            
                            
                            
                            153.5
                            
                            
                            
                            655.9Net
      loss attributable to common shareholders
                            
                            $
                            (7,140.2
                            )
                            
                            $
                            (5,760.6
                            )
                            
                            $
                            (17,279.5
                            )
                            
                            $
                            (10,089.4
                            )Basic
      and diluted loss per share
                            
                            $
                            (0.13
                            )
                            
                            $
                            (0.26
                            )
                            
                            $
                            (0.36
                            )
                            
                            $
                            (0.46
                            )Weighted
      average common shares outstanding
                            
                            
                            56,777,430
                            
                            
                            
                            22,464,655
                            
                            
                            
                            48,599,359
                            
                            
                            
                            22,049,974





The
unaudited supplemental pro forma financial information should not be considered
indicative of the results that would have occurred if the Erye Merger had been
consummated on January 1, 2009, nor are they indicative of future results.





Note
5 – Intangible Assets


At
September 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 of
September 30, 2010 and December 31, 2009, the Company’s intangible assets and
related accumulated amortization consisted of the following (in
thousands):





September30,2010
                  
                  
                  December31,2009Useful
                    Life
                  
                  
                  Gross
                  
                  
                  Accumulated
                    Amortization
                  
                  
                  Net
                  
                  
                  Gross
                  
                  
                  Accumulated
                    Amortization
                  
                  
                  NetIntangible
      assets obtained in the CBH acquisitionLease
      rights
                  
                  
                  2
                  
                  
                  $
                  704.8
                  
                  
                  $
                  (323.0
                  )
                  
                  $
                  381.8
                  
                  
                  $
                  690.7
                  
                  
                  $
                  (57.6
                  )
                  
                  $
                  633.1Customer
      list
                  
                  
                  10
                  
                  
                  
                  15,647.7
                  
                  
                  
                  (1,434.4
                  )
                  
                  
                  14,213.3
                  
                  
                  
                  15,335.1
                  
                  
                  
                  (255.6
                  )
                  
                  
                  15,079.5Patents
                  
                  
                  8
                  
                  
                  
                  153.8
                  
                  
                  
                  (17.8
                  )
                  
                  
                  136.0
                  
                  
                  
                  150.3
                  
                  
                  
                  (2.7
                  )
                  
                  
                  147.6Intangible
      assets obtained in the Stem Cell Technologies, Inc.VSEL
      patent rights
                  
                  
                  19
                  
                  
                  
                  669.0
                  
                  
                  
                  (96.8
                  )
                  
                  
                  572.2
                  
                  
                  
                  672.8
                  
                  
                  
                  (73.1
                  )
                  
                  
                  599.7Total
      Intangible Assets
                  
                  
                  
                  
                  
                  $
                  17,175.3
                  
                  
                  $
                  (1,872.0
                  )
                  
                  $
                  15,303.3
                  
                  
                  $
                  16,848.9
                  
                  
                  $
                  (389.0
                  )
                  
                  $
                  16,459.9





Total
intangible amortization expense is classified in each of the operating expense
categories for the periods included below as follows (in
thousands):





Three Months Ended September 30,
                  
                  
                  Nine Months Ended September 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Cost
      of revenues
                  
                  $
                  87.1
                  
                  
                  $
                  -
                  
                  
                  $
                  259.8
                  
                  
                  $
                  -Selling,
      general, and administrative
                  
                  
                  401.2
                  
                  
                  
                  -
                  
                  
                  
                  1,185.6
                  
                  
                  
                  8.8Research
      and development
                  
                  
                  -
                  
                  
                  
                  8.8
                  
                  
                  
                  8.8
                  
                  
                  
                  17.6





Estimated
intangible amortization expense on an annual basis for the succeeding five years
is as follows (in thousands):


19





Years Ending December 31,
                  
                  Amount2010
      (remainder)
                  
                  $
                  493.02011
                  
                  
                  1,913.12012
                  
                  
                  1,619.42013
                  
                  
                  1,619.42014
                  
                  
                  1,619.4Thereafter
                  
                  
                  8,039.0Total
                  
                  $
                  15,303.3





Note
6– Accrued Liabilities





Accrued
liabilities are as follows (in thousands):





September 30, 2010
                        
                        
                        December 31, 2009Income
      taxes payable
                        
                        $
                        1,510.8
                        
                        
                        $
                        1,842.0Patent
      infringement
                        
                        
                        747.3
                        
                        
                        
                        -VAT
      payable
                        
                        
                        641.8
                        
                        
                        
                        -Professional
      fees
                        
                        
                        458.1
                        
                        
                        
                        116.8Accrued
      construction costs
                        
                        
                        348.5
                        
                        
                        
                        -Security
      deposits
                        
                        
                        268.6
                        
                        
                        
                        -Salaries
      and related taxes
                        
                        
                        265.1
                        
                        
                        
                        531.6Utilities
      accrual
                        
                        
                        120.7
                        
                        
                        
                        -Collection
      cost
                        
                        
                        87.2
                        
                        
                        
                        85.2Benefits
      payable
                        
                        
                        82.8
                        
                        
                        
                        -Franchise
      taxes
                        
                        
                        25.4
                        
                        
                        
                        139.0Rent
      expense
                        
                        
                        24.2
                        
                        
                        
                        69.1Dividends
      payable
                        
                        
                        -
                        
                        
                        
                        69.4Other
                        
                        
                        128.7
                        
                        
                        
                        112.4$
                        4,709.2
                        
                        
                        $
                        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
for approximately $645,500. The note bore 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 approximately $761,300 and these funds were
returned when the note was repaid.




On May
25, 2010 NeoStem (China) issued a promissory note to the Bank of Rizhao Qingdao
Branch for approximately $538,000 due November 25, 2010 and bearing interest at
4.86% per annum.  The loan is collateralized by cash in a restricted bank
account totaling approximately $608,900.  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.




In
December 2009, Erye obtained a loan of approximately $2,200,500 from the
Industrial and Commercial Bank with an interest rate of 4.86% and was due in
June 2010. In April 2010 this loan was paid in full.
  Erye has
approximately $5,951,900 of notes payable outstanding as of September 30, 2010.
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 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 pledged as collateral for the balance of notes
payable at September 30, 2010 and December 31, 2009, amounted to approximately
$2,720,700 and  $3,955,400, respectively.  At September 30,
2010 and December 31, 2009 the restricted cash amounted to 45.7% and 43.2% of
the notes payable Erye issued, and the remainder of the notes payable is
collateralized by pledging the land use right Erye owns, which amounted to
approximately $1,935,100 and $1,896,900 at  September 30, 2010 and
December 31, 2009, respectively.




20


The
Company has financed certain insurance policies and has notes payable at
September 30, 2010 of approximately $54,700 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.





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 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 $153,500 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 $6,819,500 in net proceeds from the offering, after underwriting
discounts, commissions and expenses, of approximately $943,000 of which
approximately $75,400 was unpaid as of September 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 Company of
$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.




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 Erye 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 shares 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 $1,802,100, 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 $1,746,100 after deducting its offering
expenses.


21





On June
1, 2010, Fullbright Finance Limited 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, 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
$5,000,000.  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
$4,497,900.





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, 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
27, 2010, consistent with the Company’s previously disclosed intention to
provide support for a 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 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 the
Foundation.





On
September 30, 2010 a warrant holder exercised a warrant to purchase 600,000
shares of Common Stock. The exercise price was $.78 per share, resulting in
proceeds to the Company of $468,000.





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 of
17,352,028 shares of common stock are reserved for issuance upon exercise of
outstanding warrants as of September 30, 2010 at prices ranging from $0.50 to
$6.50 and expiring through April 2017.





During
the three and nine months ended September 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
                
                
                Nine Months
                
                
                ThreeMonths
                
                
                NineMonths
                
                
                Three Months
                
                
                Nine MonthsEnded
                
                
                Ended
                
                
                Ended
                
                
                Ended
                
                
                Ended
                
                
                Ended9/30/2010
                
                
                9/30/2010
                
                
                9/30/2010
                
                
                9/30/2010
                
                
                9/30/2010
                
                
                9/30/2010Warrants
      issued for investor relations services
                
                
                -
                
                
                
                200,000
                
                
                $
                -
                
                
                $
                242.7
                
                
                $
                (70.8
                )
                
                $
                121.4Warrants
      issued for consulting services
                
                
                25,000
                
                
                
                350,000
                
                
                
                32.9
                
                
                
                425.6
                
                
                
                (103.4
                )
                
                
                221.5Warrants
      issued for legal services
                
                
                -
                
                
                
                77,000
                
                
                
                -
                
                
                
                104.0
                
                
                
                26.9
                
                
                
                74.5




22





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 ofShares
                        
                        
                        Weighted
                          AverageExercise
                          Price
                        
                        
                        Weighted
                          Average
                          Remaining
                          ContractualTerm
                          (years)
                        
                        
                        Aggregate
                          Intrinsic ValueBalance
      at December 31, 2009
                        
                        
                        19,838,802
                        
                        
                        $
                        3.00Granted
                        
                        
                        1,301,417
                        
                        
                        
                        2.25Exercised
                        
                        
                        (2,025,000
                        )
                        
                        
                        1.46Expired
                        
                        
                        (1,613,191
                        )
                        
                        
                        6.54Cancelled
                        
                        
                        (150,000
                        )
                        
                        
                        2.78Balance
      at September 30, 2010
                        
                        
                        17,352,028
                        
                        
                        $
                        2.80
                        
                        
                        
                        4.0
                        
                        
                        $
                        651,689





At
September 30, 2010 the outstanding warrants by range of exercise prices are as
follows:




Weighted AverageNumber Outstanding
                  
                  
                  Remaining
                  
                  
                  Number ExercisableExercise Price
                  
                  September 30, 2010
                  
                  
                  Contractual Life (years)
                  
                  
                  September 30, 2010$0.50
      to $1.01
                  
                  
                  99,000
                  
                  
                  
                  3.11
                  
                  
                  
                  83,000$1.01
      to $1.99
                  
                  
                  1,442,709
                  
                  
                  
                  3.23
                  
                  
                  
                  1,241,709$1.99
      to $2.53
                  
                  
                  13,202,512
                  
                  
                  
                  4.51
                  
                  
                  
                  13,169,179$2.53
      to $5.99
                  
                  
                  929,928
                  
                  
                  
                  2.29
                  
                  
                  
                  929,928$5.99
      to $6.50
                  
                  
                  1,677,879
                  
                  
                  
                  1.98
                  
                  
                  
                  1,677,87917,352,028
                  
                  
                  
                  2.80
                  
                  
                  
                  17,101,695





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.  In September 2010, the Board of Directors
authorized an amendment subject to shareholder approval to further increase this
number by 2,000,000 shares.





The 2003
Equity Plan and the 2009 Equity Plan are sometimes collectively referred to as
the Company’s “U.S. Equity Plan.”




23


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 $2,453,100 and
$1,368,200 for the three months ended September 30, 2010 and 2009, respectively
and $5,982,500 and $2,766,600 for the nine months ended September 30, 2010
and 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. At September 30, 2010 there
were options to purchase 1,726,075 shares 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 the three and
nine months ended September 30, 2010 was $1.34 and $1.61, 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. The expected term is based upon observation
of actual time elapsed between date of grant and exercise of options for all
employees.





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
                  
                  
                  Nine Months EndedSeptember 30,2010
                  
                  
                  September 30,2009
                  
                  
                  September 30,2010
                  
                  
                  September 30,2009Expected
      term (in years)
                  
                  2
      to 10
                  
                  
                  
                  10
                  
                  
                  2
      to 10
                  
                  
                  
                  10Expected
      volatility
                  
                  
                  91%
      - 100
                  %
                  
                  187%
      to 197
                  %
                  
                  
                  91%
      - 122
                  %
                  
                  187%
      to 217
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %
                  
                  
                  0
                  %Risk-free
      interest rate
                  
                  
                  0.42%
      - 3.00
                  %
                  
                  3.33%
      to 3.66
                  %
                  
                  
                  0.42%
      - 3.58
                  %
                  
                  3.33%
      to 3.81
                  %




Stock
option activity under the U.S. Equity Plan is as follows:





Number of Shares
                            
                            
                            Weighted
                              Average
                              ExercisePrice
                            
                            
                            WeightedAverage
                              Remaining
                              Contractual Term
                            
                            
                            Average Intrinsic
                              ValueBalance
      at December 31, 2009
                            
                            
                            8,340,574
                            
                            
                            $
                            1.93Granted
                            
                            
                            1,906,000
                            
                            
                            
                            1.86Exercised
                            
                            
                            (90,000
                            )
                            
                            
                            1.56Forfeited
                            
                            
                            (98,360
                            )
                            
                            
                            1.61Balance
      at September 30, 2010
                            
                            
                            10,058,214
                            
                            
                            $
                            1.87
                            
                            
                            
                            8.5
                            
                            
                            $
                            2,033,736Vested
      and Exercisable at September 30, 2010
                            
                            
                            5,850,835
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            1,030,180




24





Number Outstanding
                    
                    
                    Weighted Average
                    
                    
                    Number ExercisableSeptember 30, 2010
                    
                    
                    Remaining Contractual Term
                    
                    
                    September 30, 2010Exercise Price$  0.71
      to $  1.89
                    
                    
                    4,827,000
                    
                    
                    
                    8.98
                    
                    
                    
                    2,144,000$  1.89
      to $  1.96
                    
                    
                    3,123,664
                    
                    
                    
                    7.40
                    
                    
                    
                    2,437,617$  1.96
      to $  4.96
                    
                    
                    2,056,200
                    
                    
                    
                    9.21
                    
                    
                    
                    1,217,868$  4.96
      to $  7.01
                    
                    
                    27,250
                    
                    
                    
                    4.84
                    
                    
                    
                    27,250$ 
      7.01 to $15.00
                    
                    
                    24,100
                    
                    
                    
                    4.20
                    
                    
                    
                    24,10010,058,214
                    
                    
                    
                    
                    
                    
                    
                    5,850,835





Stock
option activity under the Non U.S. Equity Plan is as follows:





Number
                    of Shares
                  
                  
                  Weighted
                    Average
                    ExercisePrice
                  
                  
                  Weighted
                    Average
                    Remaining
                    Contractual
                    Term
                  
                  
                  Average Intrinsic
                    ValueBalance
      at December 31, 2009
                  
                  
                  1,650,000
                  
                  
                  $
                  2.04Granted
                  
                  
                  1,850,000
                  
                  
                  
                  2.06Exercised
                  
                  
                  -Expired
                  
                  
                  -Cancelled
                  
                  
                  -Balance
      at September 30, 2010
                  
                  
                  3,500,000
                  
                  
                  $
                  2.05
                  
                  
                  
                  9.5
                  
                  
                  $
                  228,000Vested
      and Exercisable at Septmber 30, 2010
                  
                  
                  766,666
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  -








Number Outstanding
                      
                      
                      Weighted Average
                      
                      
                      Number ExercisableSeptember 30, 2010
                      
                      
                      Remaining Contractual Term
                      
                      
                      September 30, 2010Exercise Price$  1.65
      to $  1.93
                      
                      
                      600,000
                      
                      
                      
                      9.93
                      
                      
                      -$  1.93
      to $  2.08
                      
                      
                      1,650,000
                      
                      
                      
                      9.08
                      
                      
                      
                      416,666$  2.08
      to $  2.22
                      
                      
                      650,000
                      
                      
                      
                      9.70
                      
                      
                      
                      150,000$  2.22
      to $  2.36
                      
                      
                      600,000
                      
                      
                      
                      9.72
                      
                      
                      
                      200,0003,500,000
                      
                      
                      
                      
                      
                      
                      
                      766,666





The total
fair value of shares vested during the three and nine  months ended
September 30, 2010 was $3,334,677 and $4,781,806, 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
                  
                  
                  (10,058,214
                  )Exercised
      Options
                  
                  
                  (92,500
                  )
                  
                  
                  -Outstanding
      Options - Non US Equity Plan
                  
                  
                  
                  
                  
                  
                  (3,500,000
                  )Common
      shares issued under the option plans
                  
                  
                  (2,160,535
                  )
                  
                  
                  (885,000
                  )Total
      common shares remaining to be issued under the Option
Plans
                  
                  
                  3,938,751
                  
                  
                  
                  4,315,000




25





As of
September 30, 2010, there was approximately $9,037,725 of total unrecognized
compensation costs related to unvested stock option awards of which $5,876,909
of unrecognized compensation expense is related to stock options that vest over
a weighted average life of 2.2 years. The balance of unrecognized compensation
costs, $3,160,817, is related to stock options that vest based on the
accomplishment of business milestones as to which expense is generally
recognized when such milestones become probable of being
achieved.





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 Erye
Merger.  Increasing the value of the acquired assets to fair value,
while deductible for book purposes, is not deductible for local Chinese tax
purposes but requires recognition of the impact such non-deductibility will have
on future tax expense.  Specifically, the Company established as of
the Erye 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 PRC regulatory authorities, the WFOE
may engage in the research and 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 equipment (the
import and export do not involve the goods specifically stipulated in/by
state-operated trade, import and 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
Erye 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.





The
Company’s segment data is as follows (in thousands):


26





Three Months Ended September 30,
                              
                              
                              Nine Months Ended September 30,2010
                              
                              
                              2009
                              
                              
                              2010
                              
                              
                              2009United
      StatesStem
      Cell Revenues
                              
                              $
                              32.0
                              
                              
                              $
                              82.6
                              
                              
                              $
                              98.4
                              
                              
                              $
                              141.2Other
      Revenues
                              
                              
                              29.1
                              
                              
                              
                              2.5
                              
                              
                              
                              59.2
                              
                              
                              
                              16.5ChinaPrescription
      drugs and intermediary pharmaceutical products
                              
                              
                              16,378.1
                              
                              
                              
                              -
                              
                              
                              
                              51,500.6
                              
                              
                              
                              -Stem
      Cell Revenues
                              
                              
                              30.0
                              
                              
                              
                              -
                              
                              
                              
                              30.0
                              
                              
                              
                              -Other
      Revenues
                              
                              
                              6.4
                              
                              
                              
                              -
                              
                              
                              
                              28.1
                              
                              
                              
                              -$
                              16,475.6
                              
                              
                              $
                              85.1
                              
                              
                              $
                              51,716.3
                              
                              
                              $
                              157.7Income/(loss)
      from operations:United
      States
                              
                              $
                              (6,658.7
                              )
                              
                              $
                              (5,693.1
                              )
                              
                              $
                              (16,547.0
                              )
                              
                              $
                              (11,068.1
                              )China
                              
                              
                              914.9
                              
                              
                              
                              (1,538.2
                              )
                              
                              
                              4,691.9
                              
                              
                              
                              (2,676.6
                              )$
                              (5,743.8
                              )
                              
                              $
                              (7,231.3
                              )
                              
                              $
                              (11,855.1
                              )
                              
                              $
                              (13,744.7
                              )Total
      AssetsSeptember
      30, 2010
                              
                              
                              
                              
                              
                              
                              December
      31, 2009United
      States
                              
                              $
                              4,723.5
                              
                              
                              
                              
                              
                              
                              $
                              3,895.5China
                              
                              
                              112,247.0
                              
                              
                              
                              
                              
                              
                              
                              104,998.4$
                              116,970.5
                              
                              
                              
                              
                              
                              
                              $
                              108,893.9





Note
12 – Related Party Transactions


On April
30, 2009, the Company entered into a License and Referral Agreement with
Promethean Corporation, now Ceregenex Corporation (“Ceregenex”), 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 Ceregenex is in an exclusive relationship with
the CEO of the Company. The Company has earned $4,446 and $13,196 in royalties
in connection with this agreement during the three and nine months ended
September 30, 2010, respectively.  The royalty payments were not
material in 2009.  Additionally Ceregenex has been responsible for
referral of certain clients for the Company’s stem cell collection business and
receives a commission of 10% for such referrals.  Through September
30, 2010 these commissions were not significant.





At
September 30, 2010, Erye owed EET, the 49% shareholder of Erye,
$8,074,100.  Included in the amounts owed to EET are:


·
              Dividends
      paid and loaned back to Erye amounting to $7,847,200 and accrued interest
      of $458,700, the interest rate on this loan is
      5.31%.  Erye made an interest payment of approximately
      $195,600 in February
2010.




·
            Advances to EET of $626,600;
      and


·
                  A non interest bearing loan from
      EET of $394,800 due
2011.




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 Erye Merger with CBH (which Erye 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.


27





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 options that would have vested during the 12-month period following the date
of termination, become fully vested and , together with all other fully vested
options, 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 options which would have
vested during the 12-month period following the date of termination, become
fully vested and, together with all other fully vested options, 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 in 2009 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).





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.


28





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 was 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 is equal to the closing price of the common stock on the
Effective Date and the Option is 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.





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.  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 $158,371 has been paid.  An
additional $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 VSELTM
Technology.





As of
December 31, 2009, the Company, NeoStem (China), Inc., 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 (1) 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) install 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 PRC.  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.  See Note 1, The Company, for information on the proposed Merger
of PCT with and into a wholly-owned subsidiary of the Company.




29




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 previously  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 or
are currently subject to lock-up agreements and (ii) during much of the relevant
periods the warrants with registration rights generally have been out of the
money or are currently subject to lock-up agreements.  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 September
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.  This decision is
final.




30




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
Overview





Through
our expansion efforts within China and with the acquisition in October 2009 of a
controlling interest in Suzhou Erye Pharmaceuticals Company 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, the first
      of which is orthopedic, 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.





The
Merger – Erye





On
October 30, 2009, pursuant to the Merger Agreement with CBH, we acquired a 51%
ownership interest in Erye through a wholly owned subsidiary.  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 (the “Joint Venture Agreement”) which governs our ownership of
Erye.





Pursuant
to the terms and conditions of the Joint Venture Agreement, dividend
distributions to EET and our subsidiary (“Merger Sub”) will be made in
proportion to their respective ownership interests in Erye; provided, however,
that for the three-year period which commenced on the first day of the first
fiscal quarter after the Joint Venture Agreement became effective (currently
approximately another two years) distributions will be made as follows: (i) 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 of
September 30, 2010 distributions totaling approximately $7,306,700 had been
deferred and EET has received and lent back approximately
$7,847,200.




31




Results
of Operations





Revenue





Three
Months and Nine Months Ended September 30, 2010 and September 30,
2009





For the
three months endedSeptember 30, 2010,
total revenues were $16,475,600 compared to $85,100 for the three months
endedSeptember
30, 2009. Revenues for the three months ended September 30, 2010 were comprised
of $16,384,500 of pharmaceutical product sales, $30,000 from stem cell therapies
in China and $61,100 related to stem cell collections, license fees, royalties
and other revenue in the United States. The pharmaceutical product sales
represent sales generated by Erye.  The stem cell revenues generated
in the United States for the three months ended September 30, 2010 and 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 network. In
the three months ended September 30, 2010, NeoStem realized its first stem cell
therapy revenues in China which totaled $30,000.  In the United
States, for the three months ended September 30, 2010, revenues were
primarily made up of $27,800 from the collection and storage of autologous
adult stem cells and $14,800 of license fees. For the three months ended
September 30, 2009, we earned $79,100 from the collection and storage of
autologous adult stem cells and $6,000 from license fees. Cost of revenues for
the three months ended September 30, 2010 is comprised of Cost of goods sold of
$11,191,400  related to the sale of our pharmaceutical products,
$20,300 related to stem cell therapies in China and $21,100 of direct costs
related to the cost of collecting autologous stem cells from clients. For the
nine months ended September 30, 2010, total revenues were $51,716,300 compared
to $157,700 for the nine months ended September 30, 2009. Revenues for the nine
months ended September 30, 2010 were comprised of $51,528,700 of pharmaceutical
product sales, $30,000 from stem cell therapies in China and  $157,600
related to stem cell collections, license fees, royalties and other revenue in
the United States. The pharmaceutical product sales represent sales generated by
Erye.  The stem cell revenues generated in the United States in the
nine months ended September 30, 2010 and 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 network. For the nine months ended
September 30, 2010, we earned $94,200 from the collection and storage of
autologous adult stem cells and $44,800 of license fees. For the nine
months ended September 30, 2009, we earned $133,600 from the collection and
storage of autologous adult stem cells and $24,100 from license fees. Cost
of revenues for the nine months ended September 30, 2010 is comprised of
Cost of Goods sold of $34,931,900 related to the sale of our pharmaceutical
products, $20,300 related to stem cell therapies in China and  $63,300
of direct costs related to the cost of collecting autologous stem cells from
clients.





Gross
margin for the three and nine months ended September 30, 2010 totaled $5,242,700
and $16,700,700 respectively of which 99% is attributable to the sale of
pharmaceutical products and the balance is attributable to our stem cell
collection and therapy operations.





Operating
Expenses





Three
Months Ended September 30, 2010 Compared to the Three Months Ended
September 30, 2009





For
the three months ended September 30, 2010 operating expenses totaled
$10,986,600 compared to $7,263,200 for the three months ended
September 30, 2009, representing an increase of $3,723,400 or 51%.





For
the three months ended September 30, 2010, our selling, general, and
administrative expenses were $9,306,000 compared to $5,433,500 for
the three months ended September 30, 2009, representing an increase of
$3,872,500, which was the result of:


32




·
            Our
      efforts to establish a stem cell operation in China to provide advanced
      therapies, related processing and storage, as well as research and
      development capabilities totaled $1,614,100, an increase of $802,400. 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 $771,000.





·
            Administrative
      expenses increased by approximately $3,071,900. Approximately $1,491,600
      of this increase was the result of the Erye Merger and the attendant
      operating expenses of the Erye operation. The Company’s U.S.
      administrative operating expenses increased by $1,580,300. The use of
      equity instruments to incentivize staff, compensate directors and pay for
      services totaled $2,181,700, an increase of $666,400 over the three
      months ended September 30, 2009. Staff costs decreased by $47,800. Other
      staff related cost including travel and entertainment and operating
      expenses increased by $97,600. Professional fees, including legal and
      accounting fees increased by $458,000 as the result of costs associated
      with the pending merger with Progenitor Cell Therapy and our expanded
      operations in China.  In addition, investor relations and other
      consulting expenses increased $173,400.  Insurance expense
      increased by $62,300. Compensation expenses under the Directors Cash
      Compensation Plan adopted by the Board of Directors in the first quarter
      of 2009 increased administrative expense by $94,500. During the three
      months ended September 30, 2010 the Company contributed $75,000 to Stem
      for Life, a foundation with a mission of promoting adult stem cell
      research and in which the Company participated in founding. The balance of
      the increase in administrative expense was the result of offsetting
      changes from a variety of
activities.





·
            As
      a result of completing the Merger with CBH, our activities associated with
      the Erye Merger ended thus reducing the use of our attorney, accountant
      and other professional services and reducing our operating costs by
      $1,396,800 compared to the three month period in
  2009.





·
            Sales
      and marketing expenses increased by $1,395,700 over the three months
      ended September 30, 2009. Approximately $516,300 of this increased
      operating expense was related to the sales and marketing efforts of Erye
      and $386,900 was related to amortization of intangible assets acquired in
      the Erye Merger.  The use of equity instruments to incentivize
      staff and pay for services totaled $121,400, an increase of $62,400
      over three months ended September 30, 2009, and marketing and
      consulting fees increased approximately $276,900 in connection with
      developing new strategies and efforts to  increase our U.S.
      collection network and market penetration.  U.S. sales and
      marketing costs also increased by approximately $111,800 due to increases
      in staff costs and other operating expenses.  The balance of the
      increase in sales and marketing expenses was the result of other
      activities.





For the
three months ended September 30, 2010, our research and development expenses
totaled $1,679,900 compared to $1,829,800 for the three months ended
September 30, 2009, representing a decrease of $149,900, which was the result
of:




33




·
              Research related to our VSELTM Technology increased
      operating expenses by $798,000. Our acquisition of Erye added $245,600 of
      research and development expense to our operating expenses. Research and
      development efforts at NeoStem China added $28,400 to research and
      development expense for the three months ended September 30, 2010. The
      revaluation of equities issued to consultants reduced research and
      development expenses by approximately $500,000. During the three months
      ended September 30, 2009, the Company provided funding in the total amount
      of $721,500 in connection with establishing in China a non-profit research
      institute to promote adult stem cell research.  The Company has
      not made any similar payments in 2010.  The combination of these
      factors resulted in the reduction in research and development expense in
      2010 in comparison to 2009. The balance of the change in research and
      development expense is related to other
activities.




Nine
Months Ended September 30, 2010 Compared to the Nine Months Ended September 30,
2009





For the
nine months ended September 30, 2010 operating expenses totaled $28,555,800
compared to $13,809,400 for the nine months ended September 30, 2009,
representing an increase of $14,746,400 or 107%.





For the
nine months ended September 30, 2010, our selling, general, and administrative
expenses  were $23,442,300 compared to $11,209,800 for the nine months
ended September 30, 2009, representing an increase of $12,232,500, which was the
result of:





·
            Our
      efforts to establish a stem cell operation in China to provide advanced
      therapies and related processing and storage, as well as research and
      development capabilities totaled $4,549,000, an increase of
      $2,598,900.  These operating expenses include charges resulting
      from issuing various equity instruments to incentivize staff members and
      consultants totaling $2,069,000, an increase of
  $1,921,400.





·
            Administrative
      expenses increased by approximately $7,007,100. Approximately $3,076,800
      of this increased operating expense was the result of the Erye Merger and
      the attendant operating expenses of the Erye operation. The Company’s U.S.
      administrative operating expenses increased by $3,930,200. The use of
      equity instruments to incentivize staff, compensate directors and pay for
      services totaled $3,771,400, an increase of $984,600 over nine months
      ended September 30, 2009. Staffing costs increased by $659,800 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 $987,700 as the result
      of costs associated with the pending merger with Progenitor Cell Therapy
      and our expanded operations in China.  Investor relations
      services and other consulting fees increased by $336,800, as a result of
      increased communications with shareholders and investors.  Other
      staff related cost including travel and entertainment and operating
      expenses increased by $226,000, rent increased by $65,400 as a result of
      an increase in the cost of leasing office space in New York, and franchise
      taxes increased $123,800. Compensation expense under the Directors
      Cash Compensation Plan adopted by the Board of Directors in the first
      quarter of 2009 increased administrative expense by $280,800, insurance
      increased $161,300 and during the nine months ended September 30, 2010 the
      Company contributed $75,000 to Stem for Life, a foundation in the United
      States with a mission of promoting adult stem cell
      research.  The balance of the changes in administrative expense
      resulted from increases and decreases in other operating
      activities.


34




·
              Included in selling, general and administrative expense
      is a charge for $734,600 as the result of a judgment on May 13, 2010
      against Erye in connection with a patent dispute concerning an antibiotic
      product that has accounted for less than 2% of Erye sales in the past.
      (See Note 13 – Commitments and Contingencies for a more detailed
      discussion).




·
            As
      a result of completing the Erye Merger with CBH, our activities associated
      with the Erye Merger ended thus reducing the use of our attorney,
      accountant and other professional services and reducing our operating
      costs by $2,232,000 over the same period in
  2009.





·
            Sales
      and marketing expenses increased by $4,124,000 over the nine months ended
      September 30, 2009. Approximately $1,596,500 of this increased operating
      expense was related to the sales and marketing efforts of Erye and
      $1,153,600 was related to amortization of intangible assets acquired in
      the Erye Merger.  The use of equity instruments to incentivize
      staff and pay for services totaled $617,000, an increase of $304,400 over
      nine months ended September 30, 2009, and marketing and consulting fees
      increased approximately $831,700 in connection with developing new
      strategies and efforts to  increase our collection network and
      market penetration.  Our U.S. sales and marketing costs also
      increased by approximately $190,600 due to increases in staff costs and
      other operating expenses.  The balance of the increase in sales
      and marketing expenses was the result of other
  activities.





For the
nine months ended September 30, 2010, our research and development expenses
totaled $5,113,500 compared to $2,599,700 for the nine months ended
September 30, 2009, representing an increase of $2,513,800, which was the result
of:




·
              The use of equity instruments to incentivize research
      staff totaled $727,300, an increase of $104,000 over the nine months ended
      September 30, 2009. Research related to our VSELTM Technology increased
      operating expenses by $2,121,000. In addition, the Company initiated
      sponsored research with third parties totaling $211,200 related to our
      VSELTM Technology research. Our acquisition of Erye added $733,000 of
      research and development expense to our operating expenses. Research and
      development at NeoStem China was $45,700 for the nine months ended
      September 30, 2010. In 2009 the Company funded a grant in China, totaling
      $721,500, to create a research foundation to promote adult stem cell
      research in China and the Company has not made any similar payments in
      2010.  The combination of these factors resulted in an increase
      in research and development expense in 2010 in comparison to 2009. The
      balance of the change in research and development expense is related to
      other activities.




Dividends
on Convertible Redeemable Series C Preferred Stock.





In
connection with the Erye 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 the three and nine months ended September 30, 2010 we
recorded a dividend of $0 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
further dividends on such shares, provided however that RimAsia was entitled to
receive a cash payment of $153,500 which was equal to the dividends accrued but
unpaid from January 1, 2010 through May 17, 2010.  This payment was
made on May 25, 2010.


35




Noncontrolling
Interests





When the
Company acquired Erye from CBH it acquired a 51% interest in Erye.  In
preparing our financial statements the full operations of Erye are reflected
in our results as of and after October 30, 2009. We account for the 49%
minority shareholder share of Erye’s net income with a charge to noncontrolling
interests. For the three and nine months ended September 30, 2010, Erye’s
minority shareholder’s share of net income totaled $1,145,600 and $4,085,700,
respectively.





Other
Income and Expense




For the
three and nine months ended September 30, 2010 the Company incurred interest
expense of approximately $10,700 and $25,400 respectively, net of capitalized
interest. 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. At September 30, 2010 these
loans totaled $7,847,200. The loan calls for interest to accrue at a rate of
5.31% annually.
 
 For the
nine months ended September 30, 2010 the Company recognized other income of
$31,300 Included in this other income is income of $175,000 recognized in
connection with the extinguishment of certain liabilities that Erye determined
were no longer payable.  This income was offset by expenses related to
the modification of the term of certain warrants issued to RimAsia of
approximately $188,500.


Provision
for taxes





The
provision for taxes of $286,000 and $1,191,200 represents income taxes due on
income of Erye for the three and nine months ended September 30, 2010,
respectively, and is net of utilization of the deferred tax liability associated
with amortization of intangible assets acquired in the Erye Merger of $61,200
and $182,400 for the respective periods.


36




Liquidity
and Capital Resources





At
September 30, 2010 we had a cash balance of $4,066,700, working capital of
$7,687,700 and shareholders’ equity of $45,636,500.  During the nine
months ended September 30, 2010 we invested approximately $12,510,600 into
the business, specifically in property and equipment related to the construction
of the new manufacturing plant for Erye in China, while reducing cash used in
operating activities by $6,336,200 compared to the first nine months of
2009.





During
the nine months ended September 30, 2010, we met our immediate cash requirements
through existing cash balances, public offerings of our common stock which
raised approximately $13,138,948, the exercise of warrants and options which
raised approximately $3,101,900, 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 of $5,994,600 and $13,040,300 for the three and nine months
ended September 30, 2010, respectively. The following chart represents the net
funds provided by or used in operating, investing, and financing activities
for each period indicated (in thousands):





The Nine Months Ended(in $000)
                  
                  September 30, 2010
                  
                  
                  September 30, 2009Cash
      used in operating activities
                  
                  $
                  (3,175.7
                  )
                  
                  $
                  (9,511.9
                  )Cash
      used in investing activities
                  
                  
                  (11,019.1
                  )
                  
                  
                  (871.3
                  )Cash
      provided by financing activities
                  
                  
                  10,993.3
                  
                  
                  
                  15,801.2





Operating
Activities





Our cash
used for operating activities in the nine months ended September 30, 2010
totaled $3,175,700, which is the sum of (i) our net loss, adjusted for non-cash
expenses totaling $9,956,800 which includes, principally, common stock, common
stock options and common stock purchase warrants issued for services rendered in
the amount of $7,399,800 and depreciation and amortization of $2,557,000; (ii)
cash retained in the operation as the result of increases in accounts payable
and accrued expenses of $1,175,900 and a reduction in accounts receivable of
$1,278,600; and (iii) a decrease in cash resulting from a reduction in advance
payments and unearned revenue from customers and licensees of $392,000, cash
used for prepaids and payments of other assets of $461,743, increases in
inventory of $1,405,800 and utilization of a deferred tax liability in the
amount of $182,400.





Investing
Activities





During
the nine months ended September 30, 2010 we spent approximately $12,510,600 for
property and equipment. Erye is building a new production facility and during
the nine months ended September 30, 2010 $10,821,400 was spent on
construction.  This plant is expected to be fully operational in 2011.
The new production facility, once completed, will increase Erye’s production
capacity and should enable Erye to respond to expected increases in demand for
pharmaceutical products in China.  In March 2010 we initiated
construction of our stem cell laboratory in Beijing and through September 30,
2010 we have invested $852,200.  The balance of our capital
expenditures was spent on equipping our laboratory in Boston and our stem
cell operations in China.


37




Idle cash
in our Erye subsidiary of approximately $2,424,132 was invested in short term
instruments and proceeds from these investments of approximately $2,452,000 was
used for various operating and financing activities in the nine months ended
September 30, 2010.





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 $645,500. The note, bore an interest
rate of 4.05%, was due on June 21, 2010 and was paid in full in April 2010.
On May 25, 2010, NeoStem (China) issued a promissory note to the Bank of Rizhao
Qingdao Branch for approximately $538,000 due November 25, 2010 and
bearing interest at 4.86% per annum.  The loan is collateralized by cash in
a restricted bank account totaling $775,600. 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.




In
December 2009, Erye obtained a loan of approximately $2,200,500 from the
Industrial and Commercial Bank with an interest rate of 4.86% and was due in
June 2010. In April 2010 this loan was paid in full.





Erye has
$5,951,900 of notes payable as of September 30, 2010 and $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. At September 30, 2010, $2,720,700 of restricted cash
was pledged as collateral for the balance of notes payable which was
approximately 46% of the notes payable Erye issued, and the remaining notes
payable are collateralized by pledging Erye’s land use right.  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 $6,819,500 in net proceeds from the offering, after underwriting
discounts, commissions and other expenses, of approximately
$943,000.





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, 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 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.


38


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 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 $1,802,100,
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 $1,746,100 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 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 $5,000,000.  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
$4,497,900.





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 which commenced on the first day of the first fiscal quarter
after the Joint Venture Agreement became effective (currently approximately
another two years) 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 September 30, 2010, these loans totaled
$7,847,200 plus accrued interest of $458,687. The loan calls for interest to
accrue at a rate of 5.31% annually.  In addition, during the first
quarter of 2010 Erye made an interest payment of approximately
$195,600.





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.
In January 2010, Eyre received notification that the SFDA approved Erye’s
application for cGMP certification to manufacture solvent crystallization
sterile penicillin and freeze dried raw sterile penicillin at the new facility,
which provides for 50%  to 100% greater manufacturing
capacity, than its existing facility. Historically these lines accounted
for 20% of Erye’s sales. In June 2010, Erye passed the government inspection by
the SFDA to manufacture penicillin and cephalosporin powder at the new facility.
The facility is fully operational with respect to these lines. Erye has now
relocated 90% of its 2009 sales capacity to the new facility.  The new
facility is estimated to cost approximately $36 million, of which approximately
$29 million has been incurred through September 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 another two 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.




39




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 or WFOE. 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 be completed by the end of
2010. 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 some of 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 two 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.





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 of the relevant company),
the general reserve fund requires annual appropriation at 10% of after tax
profit (as determined under accounting principles generally accepted in the PRC
at each year-end); the appropriation to the other funds are at the discretion of
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 are 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.




40




NeoStem,
Inc. agreed to acquire  Progenitor Cell Therapy, LLC
(“PCT”),  pursuant to a merger (the “PCT Merger”) of a newly formed
wholly-owned subsidiary of NeoStem (“Subco”), with and into PCT pursuant to an
Agreement and Plan of Merger, dated September 23, 2010 (the “PCT Agreement
and Plan of Merger”).





Pursuant
to the terms of the PCT Agreement and Plan of Merger, all of the membership
interests of PCT outstanding immediately prior to the effective time of the PCT
Merger (the “Effective Time”) will be converted into the right to receive, in
the aggregate, 11,200,000 shares of the common stock of NeoStem and, subject to
the satisfaction of certain conditions, warrants to purchase a minimum of
1,000,000 and a maximum of 3,000,000 shares of NeoStem Common
Stock.





In order
to fund the development of advanced stem cell technologies and therapies in the
U.S. and China, including the VSELTM Technology licensed from the University of
Louisville and other regenerative technologies, management believes that we will
need to raise additional capital.  We will also require additional
cash in connection with our closing of the PCT Merger and expansion of the PCT
business.  We currently expect to fund our operating activities
through the use of existing cash balances, the use of a current or other 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 and
consider from time to time other restructuring activities, including with
respect to the potential divestiture of assets.





At
September 30, 2010, we had a cash balance of approximately
$4,066,700.  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.





The
following table reflects a summary of NeoStem’s contractual cash obligations as
of September 30, 2010 (in thousands):





Total
                        
                        
                        Less than 1
                          year
                        
                        
                        1-3 Years
                        
                        
                        3-5 Years
                        
                        
                        More than
                          5 YearsEmployment
      Agreements
                        
                        $
                        3,742.0
                        
                        
                        $
                        2,277.4
                        
                        
                        $
                        1,464.6
                        
                        
                        $
                        -
                        
                        
                        $
                        -Facility
      Leases
                        
                        
                        2,454.2
                        
                        
                        
                        960.4
                        
                        
                        
                        1,493.8
                        
                        
                        
                        -
                        
                        
                        
                        -License
      Fees
                        
                        
                        60.0
                        
                        
                        
                        30.0
                        
                        
                        
                        30.0
                        
                        
                        
                        -
                        
                        
                        
                        -Sponsored
      Research Agreements
                        
                        
                        854.4
                        
                        
                        
                        579.9
                        
                        
                        
                        274.5
                        
                        
                        
                        -
                        
                        
                        
                        -Consulting
      Agreements
                        
                        
                        2,770.8
                        
                        
                        
                        1,691.8
                        
                        
                        
                        1,073.0
                        
                        
                        
                        6.0
                        
                        
                        
                        -Design
      & Construction of Laboratory
                        
                        
                        1,387.1
                        
                        
                        
                        1,387.1
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Director
      Fees
                        
                        
                        90.0
                        
                        
                        
                        90.0
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -$
                        11,358.5
                        
                        
                        $
                        7,016.6
                        
                        
                        $
                        4,335.9
                        
                        
                        $
                        6.0
                        
                        
                        $
                        -





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.




41




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; (xii) factors
relating to the proposed PCT Merger;  and (xiii) the other factors
discussed or incorporated by reference 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”, in the Company’s Current Report on Form 8-K dated September 23, 2010
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.





42




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 ended September 30, 2010 covered 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.




43




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 June 30, 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.





As of
September 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.  In September 2010, this review
was commenced and is currently in process.





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.




44




(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
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
fiscal quarters ended June 30, 2010 and September 30, 2010.




45




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
have a significant number of securities convertible into, or allowing the
purchase of our common stock, and the Company anticipates issuing a substantial
number of shares of common stock and securities allowing the purchase of common
stock in the proposed PCT Merger. Investors could be subject to increased
dilution. Also, the issuance of additional shares as a result of such conversion
or purchase or the proposed PCT merger, or the subsequent sale of such shares,
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.  Additionally, pursuant to the PCT Merger we may issue up to
11,200,000 shares of common stock and warrants to purchase up to 3,000,000
shares of common stock.  There were 57,614,858 shares of our common
stock outstanding as of November 11, 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
additional 24,467,529 shares 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.





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.





As
a result of Erye’s relocation to a new manufacturing facility, Erye may
experience certain delays and disruptions in its manufacturing operations
which could adversely affect our business.





Erye has built a new production
facility for purposes of manufacturing its products and is in the process of
relocating its manufacturing operations from its existing facility to the new
facility.  The new facility is expected to be fully operational in
2011.  As a result of this relocation, Erye may experience
certain delays and disruptions in its manufacturing operations which may
adversely impact our business.




46




Taxing
authorities in the PRC may attempt to impose an enterprise income tax on the
gain on the transfer of the ownership of the 51% ownership interest in
Erye.





Transactions
involving the merger of two non-PRC companies, but that result in the change in
ownership of joint venture interests in the PRC, historically have not been
taxed by the taxing authorities in the PRC. However, the PRC State
Administration of Taxation issued the Notice on Strengthening the
Administration of Enterprise Income Tax on Equity Transfer Gains of
Non-residence Enterprise, or Circular 698, in December of 2009, according
to which, if any non-residence enterprise indirectly transfers the shares of any
residence enterprise, and if the total tax rate applicable in the
country/jurisdiction, where the offshore holding company transferred is
incorporated, is lower than 12.5% or there is no income tax on income of its
residents sourced outside of such country/region, relevant parties shall submit
the share transfer agreement and other relevant documents and information to the
competent tax authority having jurisdiction over the residence enterprise, whose
equity is indirectly transferred, within 30 days after the share transfer
agreement is signed.  Subject to approval by the State Administration
of Taxation, if the non-residence enterprise transferring party is deemed to
have indirectly transferred the shares of the residence enterprise for purpose
of evading PRC enterprise income tax through abuse of transaction structure, and
the transaction structure does not have reasonable commercial purposes, relevant
tax authorities have the right to re-determine the nature of the transaction
based on its substance and deny the existence of offshore vehicles established
for purpose of evading PRC tax and levy enterprise income tax on the share
transfer gains pursuant to PRC laws.  The tax rate applicable to the
share transfer gains under such circumstance should be 10% or lower treaty tax
rate under EIT Law and its implementation rules.  Accordingly,
recently the taxing authorities in the PRC have levied enterprise income tax at
the rate of approximately 10% of the gain on a few real estate and mining
transactions that resulted in a change in ownership in joint ventures located in
the PRC.  Circular 698 applies retrospectively and shall be deemed to
have become effective since January 1, 2008.  Although it is
still unclear on whether or not the Circular 698 shall also apply to the merger,
as opposed to share transfer, of two non-PRC companies resulting in the change
in ownership of PRC companies, there can be no assurance that the PRC taxing
authorities will not impose enterprise income tax on the gain on the transfer to
us of ownership of the 51% equity interests in Erye.




Foreign-invested
enterprises in China will be subject to city maintenance and construction tax
and education expenses surtax starting from December 1, 2010.





According
to relevant tax rules in China, foreign-invested enterprises (e.g., WFOE) were
not subject to city maintenance and construction tax and education expenses
surtax in the past; however, the State Council of PRC issued the Notice regarding Unifying Rules of
City Maintenance and Construction Tax and Education Expenses Surtax Applicable
to Foreign-invested Enterprises and Domestic Enterprises and Individuals
(Guo Fa (2010) 35) on October 18, 2010, or the State Council Notice No.
35.  According to the State Council Notice No. 35, starting from
December 1, 2010, the Interim
Measures on City Maintenance and Construction Taxpromulgated by the
State Council in the year of 1985 and theInterim Rules on Levying Education
Expenses Surtaxpromulgated by the State Council in the year of 1986, and
relevant rules, measures promulgated thereafter shall also apply to
foreign-invested enterprises, foreign enterprises and foreign
individuals.  Accordingly, foreign-invested enterprises will be
subject to city maintenance and construction tax and education expenses surtax
starting from December 1, 2010 (Erye was already subject to such
taxes).  Both city maintenance and construction tax and education
expense surtax are levied based on the value-added tax, consumer tax and
business tax actually paid by the tax payer, depending on location of the tax
payer, the tax rate of city maintenance and construction tax applicable could be
7%, 5% or 1%, and the tax rate of education expense surtax applicable is
currently 3%.





Because
of the State Council Notice No. 35, we expect that the tax liabilities of WFOE
will increase, which could have a material adverse effect on our results of
operations and financial condition.





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.




47




There
are Risks Related to PCT and the Proposed Merger with PCT.





See the
Company’s Current Report on Form 8-K filed with the SEC on September 23, 2010,
regarding certain risks relating to PCT’s business and the proposed Merger with
PCT, which risk factors under the headings “Risks Related to PCT and PCT’s
Business” and “Risks Relating to the Merger” are hereby incorporated by
reference into this quarterly report.





ITEM
2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





Effective
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, to vest as to one-third on each of the first,
second and third one-month anniversaries of the effective date of the
agreement.





Effective
July 27, 2010, consistent with the Company’s previously disclosed intention to
provide support for a 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 150,000 shares of restricted common stock.




Effective
July 30, 2010, the Company entered into a financial advisory and consulting
agreement pursuant to which this consultant was retained to provide financial
advisory as well as consulting services in connection with potential business
combinations for a three month term.  In consideration for providing
services under this agreement, in addition to certain specified cash
consideration, the Company agreed to issue to the consultant a five year warrant
to purchase 25,000 shares of restricted common stock at a per share exercise
price of $2.50, vesting as to one-third of the shares on each one month
anniversary of the effective date, with certain rights of cashless
exercise.





Effective
September 30, 2010, the Company issued 600,000 shares of restricted common stock
to a warrant holder pursuant to the exercise of a warrant issued to a consultant
for services in July 2008.  The exercise price was $.78 per share,
resulting in proceeds to the Company of $468,000.





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
                            Reference2(a)
                            Agreement
      and Plan of Merger, dated as of September 23, 2010, by and among NeoStem,
      Inc., Progenitor Cell Therapy LLC and NBS Acquisition Company LLC
      (1)
                            2.110(a)
                            Letter
      Agreement dated July 7, 2010 between NeoStem, Inc. and Catherine M. Vaczy,
      Esq.*
                            10.110(b)
                            Employment
      Agreement dated September 1, 2010 between NeoStem (China), Inc. and Ian
      Zhang*
                            10.210(c)
                            English
      Translation of Amendment Agreement to Joint Venture Contract of Suzhou
      Erye Pharmaceutical Co., Ltd. dated May 21, 2010 approved August 16,
      2010*
                            10.310(d)
                            Equity
      Pledge Agreement dated August 30, 2010 among Beijing Ruijieao
      Bio-Technology Ltd., NeoStem (China), Inc. and The Shareholder of Beijing
      Ruijieao Bio-Technology Ltd.*
                            10.410(e)
                            Exclusive
      Purchase Option Agreement dated June 21, 2010 among Beijing Ruijieao
      Bio-Technology Ltd., NeoStem (China), Inc. and The Shareholder of Beijing
      Ruijieao Bio-Technology Ltd.*
                            10.510(f)
                            Consigned
      Management and Technology Service Agreement dated June 21, 2010 among
      Beijing Ruijieao Bio-Technology Ltd., NeoStem (China), Inc. and The
      Shareholder of Beijing Ruijieao Bio-Technology Ltd.*
                            10.610(g)
                            Loan
      Transfer Agreement dated June 21, 2010 among NeoStem (China), Inc., the
      Shareholder of Beijing Ruijieao Bio-Technology Ltd. and Jianhua
      Sui*
                            10.710(h)
                            Form
      of Voting and Lock Up Agreement August/September 2010 by and between
      NeoStem, Inc. and the persons listed therein, with related Form of
      Amendment No. 1 to Voting and Lock-Up Agreement October
    2010*
                            10.831.1
                            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




48




(1)
                Filed
      with the Securities and Exchange Commission on September 23, 2010 as an
      exhibit, numbered as indicated above, to our Current Report on Form 8-K
      dated September 23, 2010, which exhibit is incorporated here by
      reference*
                Filed
      herewith**
                Furnished
      herewith





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: November
      12, 2010





By:
                /s/
      Larry A. MayLarry
      A. May, Chief Financial OfficerDate:
      November 12, 2010




By:
                  /s/
      Christopher C. DuignanChristopher
      C. Duignan, Chief Accounting OfficerDate: 
      November 12, 2010




49