September 21, 2009
Tia Jenkins
Senior Assistant Chief
Accountant
Office of Beverages, Apparel and
Healthcare Services
Division of Corporate
Finance
United States Securities and Exchange
Commission
100 F. Street, N.E.
Washington, D.C.
20549
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Re:
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NeoStem, Inc. (the “Company” or
“NeoStem”)
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Form 10-K for the fiscal year ended December 31, 2008 | |
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Filed March 31, 2009 | |
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File No. 1-33650 |
Dear Ms. Jenkins:
Thank you for accommodating us today,
September 21, 2009, to informally discuss the revenue recognition issues that
have been raised by the staff in its recent comment letters to our Form 10-K for
the fiscal year ended December 31, 2008 (the “Form 10-K”) and as subsequently
discussed in a phone conference on September 18th. As per our understanding,
the staff’s concerns are centered on the nature of the relationship between
NeoStem and its collection centers. Specifically you have proposed to us on a
preliminary basis that:
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1)
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The relationship between NeoStem
and its Collection Centers is not that of a vendor and customer/client,
and therefore if that relationship does not exist then the “start up fees”
received from the collection center can not be considered
revenue.
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2)
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If the “start up fees” received
from the collection center are not revenue, then they must be accounted
for as an offset against our operating
expenses.
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In addition, you cited EITF 02-16
“Accounting by a Customer (Including Reseller) for Certain Consideration
Received from a Vendor.” While the flow of funds in the instant case are in the
opposite direction from that which is the subject of EITF 02-16, we
believe you were also relying in part on a portion of the consensus opinion
concerning Issue 1:
420
Lexington Avenue, Suite 450, New York, NY 10170 212.584.4180
main 646.514.7787 fax
The Task Force reached a consensus that
cash consideration represents a reimbursement of costs incurred by the customer
to sell the vendor's products and should be characterized as a reduction of that
cost when recognized in the customer's income statement if the cash
consideration represents a reimbursement of a specific, incremental,
identifiable cost incurred by the customer in selling the vendor's products or
services. If the amount of cash consideration paid by the vendor exceeds the
cost being reimbursed, that excess amount should be characterized in the
customer's income statement as a reduction of cost of sales when recognized in
the customer's income statement.
We respectfully submit that this is not an
appropriate characterization of our relationship with our collection centers
and, accordingly, the accounting provided for in EITF 02-16 does not
apply. NeoStem’s service is unique and we submit, as further
described in this letter, that our relationship with our collection centers is
in fact that of a licensor and licensee.
We would like to start by giving you
more detailed background information regarding us and our
business. NeoStem is a pioneer in providing adult stem cell
collection, processing and banking for healthy individuals in advance of medical
need. With the exception of umbilical cord blood banks, there are no medical
service businesses similar to NeoStem and we have been obligated to create our
business model without benefit of other examples. We had several alternatives in
structuring the operation of our collection centers:
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1)
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Own and operate our own collection
centers.
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When NeoStem’s predecessor company was
first organized in 2003, it did open a small collection center. Prior to the
assets of the original NeoStem company being sold to the present company in
2006, the company-owned facility was closed. As the business matures, we will
revisit this business model and open our own collection centers if and when we
feel it in our best interests.
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2)
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Contract with companies that
provide cell collection services for current medical
needs.
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We have contracted with a company that
provides cell collection services and has a large facility for that purpose and
have collected limited numbers of clients at this facility. However, this
facility is not situated conveniently to individuals that have the disposable
income necessary to take advantage of our service. We have continued the
contractual arrangement because the cell collection service also provides mobile
services that can support some of our current collection
centers.
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3)
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Enter into development agreements
with third parties to develop collection centers in designated regions of
the country and then enter into individual license agreements with NeoStem
for each collection center created under the development
agreement. The development agreements gave exclusive rights to
establish a collection center in a particular
territory.
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We have entered into development
agreements from which one collection center was developed.
2
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4)
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License physicians and physician
practices to be collection centers for
NeoStem.
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We believe that establishing collection
centers in physician offices allows NeoStem to be located in communities with
residents having the disposable income necessary to take advantage of our
service. In addition, each physician has an established patient roll that
provides an immediate source of potential clients. The physicians and physician
practices that have joined our collection center network have not done so to
engage in contract work or to fill idle unproductive space but rather they have
paid fees to NeoStem to become a part of the collection network in order to
enhance their medical practice and to have access our proprietary stem cell
technology. In fact, the second recital in our Collection Center Agreement
states “…Practice desires to enhance the scope of services available to its
patients to include Stem Cell Collection Services…” The relationship between
NeoStem and its collection center is that of licensor and licensee, and in
essence our collection center agreements are license
agreements.
The Collection Center Agreement is
effectively a license that grants the physician the right to participate in our
stem cell collection network and access to our stem cell banking technology,
which includes our know-how, trade secrets, copy rights and other intellectual
property rights owned by us and utilized in connection with the delivery of stem
cell collection services. Our stem cell banking technology is
proprietary and the subject of pending patent applications. The collection
centers are licensed in the State in which the center is located to the extent
required by State law and NeoStem has certain State and Federal licenses and
registrations based on NeoStem’s role in the collection process. The
ability of the physician practice to offer this service is in part dependant on
our regulatory licenses and totally dependent on its right to our proprietary
technology. Our determination that our Collection Center Agreements are license
agreements is based on the underlying nature of the arrangements we have entered
into with our collection centers, the language in our agreements and the
definition of a license agreement as it is generally understood within the
larger framework of business law concepts and definitions. In this
context, we submit to the staff the following definition of a license agreement,
as it appears in a popular business dictionary, which is consistent with our
independent knowledge and other research, providing in relevant
part:
“A
written contract under
which the owner of
a copyright,
know
how,
patent,
service mark, trademark,
or other intellectual
property,
allows a licensee to
use, make, or sell copies of
the original.
Such agreements usually
limit the scope or
field of
the licensee, and specify whether the license is
exclusive or
non-exclusive, and whether the licensee will pay royalties or
some other consideration in
exchange…
licensing agreements
are mainly used in commercialization of
a technology....”
3
The physician practice typically pays an up-front licensing fee
to receive access to and
transfer of our stem cell technology and know-how. We recognize revenue from these agreements in accordance with SEC
Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial
Statements” (“SAB 101”) as amended by SAB 104, accounting guidance
that added SAB Topic 13 – “Revenue Recognition” to the SAB codification. (See
below for specific guidance we have followed from SAB Topic 13). As
part of the accounting for the up-front license revenue, revenue from the
up-front license fee is recognized based on such factors as when the payment is
received, collectability and when all material services or conditions relating
to the sale have been substantially performed based on the terms of the
agreement. The Company has seven active licensing agreements
relating to collection
centers throughout the
United States of America.
Our collection center
agreements:
(i) grant to the Practice
during the term “a non-exclusive, non-transferable license, without the right to
grant sublicenses, to use the Intellectual Property and the Marks solely in
connection with the delivery of Stem Cell Collection Services at the Practice
Site.”
(a) “Intellectual
Property” is defined as
“all know-how, trade secrets, copyrights and other intellectual property rights
(excluding the Marks) that NeoStem owns or otherwise has the right to grant
licenses under and are relevant to the delivery of Stem Cell Collection
Services.”
(b) “Marks” are defined as “the ‘NeoStem’ mark and
name, and such other marks and names as may be designated by NeoStem from time
to time by written notice to Practice.”
(c) “Stem Cell
Collection Services” are
defined as “adult stem cell collection, processing, cryopreservation and storage
services to facilitate autologous stem cell transplant.”
(d) In the collection center
agreement, the Practice acknowledges that as between the Practice and NeoStem,
NeoStem is the sole and exclusive owner of the Intellectual Property and the
Marks, that Practice will not obtain any right, title or interest in the Marks
by virtue of its use of the Marks, and any additional goodwill associated with
the Marks that is created through use by Practice of the Marks shall inure
solely to the benefit of NeoStem, and that Practice has and will obtain no
right, title or interest in any of the Intellectual Property or Marks other than
the license rights expressly granted in the Collection Center
Agreement. Further, a Practice’s rights to use any of the Marks is
conditioned upon the Practice complying with all of its obligations under the
agreement and complying with NeoStem’s policies and procedures in all material
respects.
(ii) grant to the Practice “a
non-exclusive license to use (but not to modify) the Client Agreements, policies
and procedures and check lists in connection with the delivery of Stem Cell
Collection Services.”
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(iii) provide for upfront and
ongoing payments during the term of the agreement in consideration for the grant
of the license.
We believe the above clearly
demonstrates that the relationship between NeoStem and its collection centers is
that of licensor and licensee.
We note that the fees realized from our
collection centers have been referred to collectively as “Start up fees” in our
financial statement footnotes, general ledgers and financial workpapers during
the short period of time that we as a young company have been engaged in this
business. Now that we are being asked to give further clarification
and definition to such fees, we believe that the “start-up” fees (reflected
below as the “Practice Marketing Fees”) are most appropriately categorized as
upfront licensing fees and the periodic, ongoing fees (reflected below as the
“Network Services Fees”) are most appropriately categorized as license
maintenance fees. In addition, please note that over time, we have
reduced the upfront licensing fees and parsed them into a series of fees due
over specified periods of time. We did this to make the fees more affordable and
to tie to the expected growth in business of the Collection
Center.
The initial fees due from a Collection
Center are presently described in the collection center agreements as a
“Practice Marketing Fee,” with periodic “Network Service Fees” (payable
quarterly or annually) due over the remainder of the
agreement.
The Practice Marketing Fee is paid “in
consideration of the staff training, access to and the right to use NeoStem’s
know-how, protocols, procedures, Client Agreements and Marks.” It
should be noted that the collection center is responsible for any travel,
lodging and other related expenses incurred in connection with the
training.
The periodic Network Services Fee is
paid “in consideration of NeoStem’s ongoing support such as amendments to the
Client Agreements, updated standard operating procedures, and updated policies
to comply with the changing standards, ongoing administrative services including
billing and collection, stem cell collection support and additional marketing
support.” Although the description of these fees may appear to imply that the
periodic fees are for reimbursement of costs associated with the activities
described above, it would be more accurately described as a fee for maintaining,
and access to, the general infrastructure associated with Stem Cell
Collections.
We believe that the contractual
description of the fees received from Collection Centers, as well as the other
relevant provisions of the agreements as described above, further
support our position that the relationship between NeoStem and Collection Center
is that of a licensor and licensee. Moving forward, we will strive to
ensure that the nature of this licensor/licensee relationship is given greater
definition in the agreements as well as in our financial and other reporting
matters relating thereto.
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In reviewing the accounting literature
concerning fees paid by licensees to licensors, we have noted the following
citation:
”Staff
Accounting Bulletin Topic 13.A.3.(f).
f.
Nonrefundable up-front
fees
Question
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Facts: Registrants may
negotiate arrangements pursuant to which they may receive nonrefundable fees
upon entering into arrangements or on certain specified dates. The fees may
ostensibly be received for conveyance of a license or other intangible right or
for delivery of particular products or services. Various business factors may
influence how the registrant and customer structure the payment terms. For
example, in exchange for a greater up-front fee for an intangible right, the
registrant may be willing to receive lower unit prices for related products to
be delivered in the future. In some circumstances, the right, product, or
service conveyed in conjunction with the nonrefundable fee has no utility to the
purchaser separate and independent of the registrant's performance of the other
elements of the arrangement. Therefore, in the absence of the registrant's
continuing involvement under the arrangement, the customer would not have paid
the fee. Examples of this type of arrangement include the
following:
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A
registrant sells a lifetime membership in a health club. After paying a
nonrefundable “initiation fee,” the customer is permitted to use the
health club indefinitely, so long as the customer also pays an additional
usage fee each month. The monthly usage fees collected from all customers
are adequate to cover the operating costs of the health
club.
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A
registrant in the biotechnology industry agrees to provide research and
development activities for a customer for a specified term. The customer
needs to use certain technology owned by the registrant for use in the
research and development activities. The technology is not sold or
licensed separately without the research and development activities. Under
the terms of the arrangement, the customer is required to pay a
nonrefundable “technology access fee” in addition to periodic payments for
research and development activities over the term of the
contract.
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A
registrant requires a customer to pay a nonrefundable “activation fee”
when entering into an arrangement to provide telecommunications services.
The terms of the arrangement require the customer to pay a monthly usage
fee that is adequate to recover the registrant's operating costs. The
costs incurred to activate the telecommunications service are
nominal.
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A
registrant charges users a fee for non-exclusive access to its web site
that contains proprietary databases. The fee allows access to the web site
for a one-year period. After the customer is provided with an
identification number and trained in the use of the database, there are no
incremental costs that will be incurred in serving this
customer.
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A
registrant charges a fee to users for advertising a product for sale or
auction on certain pages of its web site. The company agrees to maintain
the listing for a period of time. The cost of maintaining the
advertisement on the web site for the stated period is
minimal.
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A
registrant charges a fee for hosting another company's web site for one
year. The arrangement does not involve exclusive use of any of the hosting
company's servers or other equipment. Almost all of the projected costs to
be incurred will be incurred in the initial loading of information on the
host company's internet server and setting up appropriate links and
network connections.
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Question: Assuming these
arrangements qualify as single units of accounting under EITF Issue 00-21, when should the
revenue relating to nonrefundable, up-front fees in these types of arrangements
be recognized?
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Interpretive Response:
The staff believes that registrants should consider the specific facts and
circumstances to determine the appropriate accounting for nonrefundable,
up-front fees. Unless the up-front fee is in exchange for products
delivered or services performed that represent the culmination of a
separate earnings process, the deferral of revenue is
appropriate.
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While
the incurrence of nominal up-front costs helps make it clear that there is
not a separate earnings event in the telecommunications example above,
incurrence of substantive costs, such as in the web hosting example above,
does not necessarily indicate that there is a separate earnings event.
Whether there is a separate earnings event should be evaluated on a
case-by-case basis. Some have questioned whether revenue may be recognized
in these transactions to the extent of the incremental direct costs
incurred in the activation. Because there is no separable deliverable or
earnings event, the staff would generally object to that approach, except
where it is provided for in the authoritative literature (e.g., Statement
51).
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Supply
or service transactions may involve the charge of a nonrefundable initial
fee with subsequent periodic payments for future products or services. The
initial fees may, in substance, be wholly or partly an advance payment for
future products or services. In the examples above, the on-going rights or
services being provided or products being delivered are essential to the
customers receiving the expected benefit of the up-front payment. Therefore, the
up-front fee and the continuing performance obligation related to the
services to be provided or products to be delivered are assessed as an
integrated package. In such circumstances, the staff believes that
up-front fees, even if nonrefundable, are earned as the products and/or
services are delivered and/or performed over the term of the arrangement
or the expected period of performance and
generally should be deferred and recognized systematically over the
periods that the fees are earned. [emphasis added]
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We
believe that based on the nature of the transactions, the governing
documents, a detailed interpretation of SAB Topic 13 A3(f), and our
summary analysis as described in this letter, the relationship of NeoStem to its
collection centers is one of licensor and licensee and the upfront and ongoing
fees we receive from a collection center should be recognized as revenue, not as
cost recovery, and amortized over some appropriate period of time as we have
proposed in our previous communications. We trust that this
letter addresses the concerns raised by the Staff, and respectfully request the
Staff’s consideration of our interpretive analysis and viewpoint.
Assuming
that the Staff does not object to our analysis and conclusion, we believe it is
important to address how we would propose to disclose the fees received from our
Collection Centers in future financial statements.
Our
revenue recognition policy in our 10K for 2008 was stated as
follows:
Revenue
Recognition: 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 also earns revenue, in the
form of start up fees, from physicians seeking to establish autologous adult
stem cell collection centers. These fees are in consideration of the Company
establishing a service territory for the physician. Start up fees
are recognized once the
agreement has been signed and the physician has been qualified by the Company’s
credentialing committee.
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In the quarter ended June 30, 2009 we
revised our revenue recognition policy to state as follows:
Revenue Recognition: 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 also earns revenue, in the form of start up fees, from physicians
seeking to establish autologous adult stem cell collection centers. Start up
fees are billed once the agreement has been signed and the physician has been
qualified by the Company’s credentialing committee. During the quarter ended
June 30, 2009, the Company has modified its revenue recognition policy relative
to these fees to recognize such fees as revenues ratably over the appropriate
period of time to which the revenue element relates. Previously these fees were
recognized in full when agreements were signed and the physician had been
qualified by the Company’s credentialing committee. This modification
of our revenue recognition policy did not have a material impact on our results
of operations
We
propose a further modification of our revenue recognition policy as
follows:
Revenue Recognition: 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 also earns revenue, in the form of license fees, from physicians seeking
to establish autologous adult stem cell collection centers. These license fees
are billed upon signing of the collection center agreement and qualification of
the physician by the Company’s credentialing committee and at various times
during the term of license agreement based on the terms of the specific
agreement. During the quarter ended June 30, 2009, the Company modified its
revenue recognition policy relative to these license fees to recognize such fees
as revenues ratably over the appropriate period of time to which the revenue
element relates. Previously these license fees were recognized in full when
agreements were signed and the physician had been qualified by the Company’s
credentialing committee. This modification of our revenue recognition
policy did not have a material impact on our results of operations.
We
believe the proposed disclosure above, accurately describes the Company’s
revenue recognition policy with respect to licensing fees and addresses the
points raised by the Staff. We propose including such disclosure on a
prospective basis in future filings, as the accounting impact of the revenue
recognition policy as described would not be material to prior
filings
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Please
contact me if you have any questions relating to the matters discussed in this
letter. I may be reached at (212) 584-4171 or the address set forth
on the first page of this letter.
Very truly yours,
/s/ Catherine M.
Vaczy
Catherine M. Vaczy
Vice President and General
Counsel
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