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, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to --------------- ------------------
Commission file number 0-10909
NEOSTEM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-2343568
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
420 LEXINGTON AVE, SUITE 450, NEW YORK, NEW YORK 10170
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: 212-584-4180
(FORMERLY: PHASE III MEDICAL, INC.
330 SOUTH SERVICE ROAD, SUITE 120, MELVILLE, NEW YORK 11747)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [_] Accelerated Filer [_] Non-accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [X] No [_]
19,636,799 SHARES, $.001 PAR VALUE, AS OF NOVEMBER 13, 2006
(Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date)
PAGE NO.
Part I - Financial Information:
Item 1. Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheets
At September 30, 2006 and December 31, 2005 3
Consolidated Statements of Operations
For the three months and nine months
ended September 30, 2006 and 2005 4
Consolidated Statements of Cash Flows
for the nine months ended
September 30, 2006 and 2005 5
Notes to Unaudited Consolidated Financial
Statements 6-18
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18-21
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 22
Item 4. Controls and Procedures 22
Part II - Other Information:
Item 1. Legal Proceedings 23
Item 1A. Risk Factors 23-25
Item 2. Unregistered Sales of Equity Securities
and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of
Securityholders 25-26
Item 5. Other Information 26
Item 6. Exhibits 26
Signatures 26
-2-
NEOSTEM, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
September 30, December 31,
2006 2005
------------ ------------
Current assets:
Cash and cash equivalents $ 1,320,486 $ 488,872
Prepaid expenses and other current assets 79,496 18,447
------------ ------------
Total current assets 1,399,982 507,319
Property and equipment, net 74,746 1,488
Deferred acquisition costs 5,719 19,121
Goodwill 558,169 --
Other assets -- 114,753
------------ ------------
$ 2,038,616 $ 642,681
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Interest and dividends payable - preferred stock $ -- $ 528,564
Accounts payable 60,162 256,976
Accrued liabilities 124,946 617,196
Due to related party - current portion 125,000 --
Notes payable 78,654 135,000
Notes payable - related parties -- 48,000
Convertible promissory notes - net of debt discount
of $1,235 and $83,333
136,265 166,667
Capitalized lease obligations - current portion 23,820 --
------------ ------------
Total current liabilities 548,847 1,752,403
Unearned revenues 7,959 26,745
Due to related party - long-term portion 50,881 --
Capitalized lease obligations 45,733 --
Series A mandatorily redeemable convertible preferred stock -- 681,171
------------ ------------
Total Liabilities 653,420 2,460,319
------------ ------------
Stockholders' Equity/(Deficit):
Preferred stock; authorized, 5,000,000 shares
Series B convertible redeemable preferred stock,
liquidation value 10 shares of common stock per
share; $0.01 par value; authorized, 825,000 shares;
issued and outstanding, 10,000 shares
100 100
Common stock, $.001 par value; authorized,
500,000,000 shares; issued and outstanding,
19,494,754shares at September 30, 2006 and
7,054,386 shares at December 31, 2005 19,496 70,545
Additional paid-in capital 19,814,921 12,367,082
Accumulated deficit (18,449,321) (14,255,365)
------------ ------------
Total stockholders' equity/(deficit) 1,385,196 (1,817,638)
------------ ------------
$ 2,038,616 $ 642,681
============ ============
See accompanying notes to consolidated financial statements
-3-
NEOSTEM, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- ----------------------------------
2006 2005 2006 2005
------------ ------------- -------------- ------------
Earned revenues $ 6,262 $ 8,218 $ 18,786 $ 28,201
Direct costs 4,467 5,750 13,401 19,770
------------ ------------ -------------- ------------
Gross profit 1,795 2,468 5,385 8,431
Selling, general and administrative 999,825 538,070 2,978,725 1,112,331
Purchase of medical royalty stream 6,540 6,540
------------ ------------ -------------- ------------
Operating loss (998,030) (542,142) (2,973,340) (1,110,440)
Other income (expense):
Interest income 4,896 -- 7,440 --
Interest expense (814,173) (21,288) (1,218,122) (71,884)
Interest expense - Series A
mandatorily redeemable convertible
preferred stock -- (11,921) (9,934) (35,763)
------------ ------------ -------------- ------------
Net loss attributable to common
stockholders $ (1,807,307) $ (575,351) $ (4,193,956) $ (1,218,087)
============ ============ ============== ============
Net loss per common share ($ 0.11) ($ 0.11) ($ 0.36) ($ 0.28)
============ ============ ============== ============
Weighted average
common shares outstanding 16,554,141 5,123,178 11,565,206 4,325,732
============ ============ ============== ============
See accompanying notes to consolidated financial statements
-4-
NEOSTEM, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended September 30,
--------------------------------------
2006 2005
-------------- -------------
Cash flows from operating activities:
Net loss $(4,193,956) $(1,218,087)
Adjustments to reconcile net loss to net cash used in
operating activities:
Common shares issued and
stock options granted for services
rendered and interest expense 1,583,923 239,318
Depreciation 18,959 1,468
Amortization of debt discount 211,265 5,882
Series A mandatorily redeemable
convertible preferred stock
dividends 9,934 35,763
Deferred acquisition costs 13,401 19,770
Changes in operating asset and liabilities:
Prepaid expenses and other current assets (62,731) (2,985)
Unearned revenues (18,786) (28,201)
Accounts payable, accrued expenses, and other current
liabilities (429,694) 469,581
----------- -----------
Net cash used in operating activities
(2,867,684) (477,491)
----------- -----------
Cash flow from investing activities:
Acquisition of property and equipment (13,073) --
----------- -----------
Net cash used in investing activities (13,073) --
----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 3,573,068 287,000
Proceeds from advances on notes payable 180,396 55,000
Payments of capitalized lease obligations (12,221) --
Net Proceeds - advances on notes payable -- related party -- 48,000
Proceeds - convertible debentures -- related party -- 100,000
Proceeds from sale of convertible debentures 87,500 --
Repayments of notes payable (116,373) (30,000)
----------- -----------
Net cash provided by financing activities 3,712,370 460,000
----------- -----------
Net increase/(decrease) in cash and cash equivalents 831,614 (17,491)
Cash and cash equivalents at beginning of period 488,872 27,868
----------- -----------
Cash and cash equivalents at end of period $ 1,320,486 $ 10,377
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 261,354 $ 64,166
Supplemental Schedule of Non-cash Financing Activities:
Issuance of shares for purchase of NS California $ 200,000 $ --
Net accrual of dividends on Series A Preferred Stock $ 9,935 $ 35,763
Issuance of common stock for services rendered $ 128,398 $ 236,122
Compensatory element of stock options $ 412,153 $ 3,196
See accompanying notes to consolidated financial statements
-5-
NEOSTEM, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - THE COMPANY
We are in the business of operating a commercial autologous (donor and
recipient are the same) adult stem cell bank and are pioneering the
pre-disease collection, processing and long-term storage of adult stem cells
that donors can access for their own present and future medical treatment. On
January 19, 2006 we consummated the acquisition of the assets of NS
California, Inc., a California corporation ("NS California") relating to NS
California's business of collecting and storing adult stem cells. Effective
with the acquisition, the business of NS California became our principal
business, rather than our historic business of providing capital and business
guidance to companies in the healthcare and life science industries. We now
provide adult stem cell processing, collection and banking services with the
goal of making stem cell collection and storage widely available, so that the
general population will have the opportunity to store their own stem cells
for future healthcare needs. We also hope to become the leading provider of
adult stem cells for therapeutic use in the burgeoning field of regenerative
medicine for potentially addressing heart disease, types of cancer and other
critical health problems.
We have engaged in various capital raising activities to pursue new business
opportunities, raising approximately $1,325,000 in 2005 and $3,573,000 in
2006 through the sale of our Common Stock, warrants and convertible
promissory notes. Such capital raising activities are enabling us to pursue
our business plan and grow our adult stem cell collection and storage
business, including expanding marketing and sales activities. However, in
order to fully develop our business, we will need to raise additional funds.
On August 29, 2006, our stockholders approved an amendment to our Certificate
of Incorporation to effect a reverse stock split of our Common Stock at a
ratio of one-for-ten shares and to change our name from Phase III Medical,
Inc. to NeoStem, Inc. All numbers in this report have been adjusted to
reflect the reverse stock split which was effective as of August 31, 2006.
NeoStem, Inc. was incorporated under the laws of the State of Delaware in
September 1980 under the name Fidelity Medical Services, Inc. Our corporate
headquarters is located at 420 Lexington Avenue, Suite 450, New York, NY
10170, our telephone number is (212) 584-4184 and our website address is
www.neostem.com. The information contained on our website is not a part of
this filing.
Prior to the NS California acquisition, the business of the Company was to
provide capital and business guidance to companies in the healthcare and life
science industries, in return for a percentage of revenues, royalty fees,
licensing fees and other product sales of the target companies. Additionally,
through June 30, 2002, the Company was a provider of extended warranties and
service contracts via the Internet at warrantysuperstore.com. The Company is
still engaged in the "run off" of such extended warranties and service
contracts.
NOTE 2 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States of America for
complete financial statements. In the opinion of management, the statements
contain all adjustments (consisting only of normal recurring accruals)
necessary to present fairly the financial position as of September 30, 2006
and December 31, 2005, the results of operations for the three months and
nine months ended September 30, 2006 and 2005 and the cash flows for the
nine months ended September 30, 2006 and 2005. The results of operations for
the three months and nine months ended September 30, 2006 are not
necessarily indicative of the results to be expected for the full year. All
numbers in this report have been adjusted to reflect the reverse stock split
which was effective as of August 31, 2006.
The Company's consolidated financial statements have been prepared assuming
the Company will continue as a going concern. The Company currently has no
cash generating revenues and limited financial resources to pay its current
expenses and liabilities. These factors raise substantial doubt about the
Company's ability to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from the outcome
of this uncertainty.
The December 31, 2005 balance sheet has been derived from the audited
financial statements at that date included in the Company's Annual Report on
Form 10-K/A. These unaudited financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K/A.
NOTE 3 -RECENT ACCOUNTING PRONOUNCEMENTS
In February 2006, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 155, Accounting for Certain Hybrid Financial Instruments- An
Amendment of FASB No. 133 and 140. The purpose of SFAS statement No. 155 is
to simplify the accounting for certain hybrid financial instruments by
permitting fair value re-measurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation.
SFAS No. 155 also eliminates the restriction on passive derivative
instruments that a qualifying special-purpose entity may hold. SFAS No. 155
is effective for all financial instruments acquired or issued after the
beginning of any entity's first fiscal year beginning after September 15,
2006. We believe that the adoption of this standard on January 1, 2007 will
not have a material effect on our consolidated financial statements.
-6-
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of
Financial Assets, an Amendment of SFAS No. 140. SFAS No. 156 requires
separate recognition of a servicing asset and a servicing liability each time
an entity undertakes and obligation to service a financial asset by entering
into a servicing contract. This statement also requires that servicing assets
and liabilities be initially recorded at fair value and subsequently adjusted
to the fair value at the end of each reporting period. This statement is
effective in fiscal years beginning after September 15, 2006. We believe that
the adoption of this standard on January 1, 2007 will not have a material
effect on our consolidated financial statements.
In July 2006, the FASB interpretation ("FIN") No. 48, Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109,
was issued regarding accounting for, and disclosure of, uncertain tax
positions. This Interpretation clarifies the accounting for uncertainty in
income taxes recognized in an enterprise's financial statements in accordance
with FASB Statement No. 109, "Accounting for Income Taxes," and prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken
in a tax return. The interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. This interpretation is effective for fiscal years
beginning after December 15, 2006. The Company is currently evaluating the
impact this interpretation will have on its results of operations and
financial position.
In September 2006, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 157 Fair Value Measurements. This statement defines fair value,
establishes a fair value hierarchy to be used in generally accepted
accounting principles and expands disclosures about fair value measurements.
Although this statement does not require any new fair value measurements, the
application could change current practice. The statement is effective for
fiscal years beginning after November 15, 2007. The Company is currently
evaluating the impact of this statement to its financial position and results
of operations.
In September 2006, the FASB issued SFAS No. 158 Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an Amendment of FASB
Statements No. 87, 88, 106, and 132(R). This statement requires a company to
recognize the funded status of a benefit plan as an asset or a liability in
its statement of financial position. In addition, a company is required to
measure plan assets and benefit obligations as of the date of its fiscal
year-end statement of financial position. The recognition provision of this
statement, along with additional disclosure requirements, is effective for
fiscal years ending after December 15, 2006, while the measurement date
provision is effective for fiscal years ending after December 15, 2008. The
Company is currently evaluating the impact of this statement to its financial
position.
NOTE 4 -STOCK OPTIONS
The Company's Equity Participation Plan (the "Plan") permits the grant of
share options and shares to its employees, Directors, consultants and
advisors for up to 25,000,000 shares of common stock as stock compensation.
The Board of Directors has adopted a resolution providing that it will not
grant options to purchase shares, in any calendar year, exceeding 10% of the
number of shares of Common Stock outstanding on a fully diluted basis. All
stock options under the Equity Participation Plan are generally granted at
the fair market value of the common stock at the grant date. Employee stock
options vest ratably over a period determined at time of grant and generally
expire 10 years from the grant date.
Effective January 1, 2006, the Company's Plan is accounted for in accordance
with the recognition and measurement provisions of Statement of Financial
Accounting Standards ("FAS") No. 123 (revised 2004), Share-Based Payment
("FAS 123(R)"), which replaces FAS No. 123, Accounting for Stock-Based
Compensation, and supersedes Accounting Principles Board Opinion ("APB") No.
25, Accounting for Stock Issued to Employees, and related interpretations.
FAS 123 (R) requires compensation costs related to share-based payment
transactions, including employee stock options, to be recognized in the
financial statements. In addition, the Company adheres to the guidance set
forth within Securities and Exchange Commission ("SEC") Staff Accounting
Bulletin ("SAB") No. 107, which provides the Staff's views regarding the
interaction between SFAS No. 123(R) and certain SEC rules and regulations and
provides interpretations with respect to the valuation of share-based
payments for public companies.
Prior to January 1, 2006, the Company accounted for similar transactions in
accordance with APB No. 25 which employed the intrinsic value method of
measuring compensation cost. Accordingly, compensation expense was not
recognized for fixed stock options if the exercise price of the option
equaled or exceeded the fair value of the underlying stock at the grant date.
-7-
While FAS No. 123 encouraged recognition of the fair value of all stock-based
awards on the date of grant as expense over the vesting period, companies
were permitted to continue to apply the intrinsic value-based method of
accounting prescribed by APB No. 25 and disclose certain pro-forma amounts as
if the fair value approach of SFAS No. 123 had been applied. In December
2002, FAS No. 148, Accounting for Stock-Based Compensation-Transition and
Disclosure, an amendment of SFAS No. 123, was issued, which, in addition to
providing alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation,
required more prominent pro-forma disclosures in both the annual and interim
financial statements. The Company complied with these disclosure requirements
for all applicable periods prior to January 1, 2006.
In adopting FAS 123(R), the Company applied the modified prospective approach
to transition. Under the modified prospective approach, the provisions of FAS
123 (R) are to be applied to new awards and to awards modified, repurchased,
or cancelled after the required effective date. Additionally, compensation
cost for the portion of awards for which the requisite service has not been
rendered that are outstanding as of the required effective date shall be
recognized as the requisite service is rendered on or after the required
effective date. The compensation cost for that portion of awards shall be
based on the grant-date fair value of those awards as calculated for either
recognition or pro-forma disclosures under FAS 123.
As a result of the adoption of FAS 123 (R), the Company's results for the
three month and nine month period ended September 30, 2006 include
share-based compensation expense totaling approximately $76,392 and $462,908
respectively. Such amounts have been included in the consolidated statements
of income within general and administrative expenses. Stock compensation
expense recorded under APB No. 25 in the consolidated statements of
operations for the three months and nine months ended September 30, 2005
totaled $0.
Stock option compensation expense in 2006 is the estimated fair value of
options granted amortized on a straight-line basis over the requisite service
period for the entire portion of the award.
The weighted average estimated fair value of stock options granted in the
three months and nine months ended September 30, 2006 was $.54 and $.61,
respectively. The weighted average estimated fair value of stock options
granted in the three months and nine months ended September 30, 2005 was $.50
and $.51, respectively. The fair value of options at the date of grant was
estimated using the Black-Scholes option pricing model. During 2006, the
Company took into consideration the guidance under SFAS 123(R) and SAB No.
107 when reviewing and updating assumptions. The expected volatility is based
upon historical volatility of our stock and other contributing factors. The
expected term is based upon observation of actual time elapsed between date
of grant and exercise of options for all employees. Previously such
assumptions were determined based on historical data.
The assumptions made in calculating the fair values of options are as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------- --------------------------------------
2006 2005 2006 2005
----------------- ----------------- ----------------- -----------------
Expected term (in 10 10 10 10
years)
Expected volatility 179% 200% 193% 200%
Expected dividend
yield 0% 0% 0% 0%
Risk-free interest
rate 2.80% 2.80% 2.80% 2.80%
The following table addresses the additional disclosure requirements of FAS
123(R) in the period of adoption. The table illustrates the effect on net
income and earnings per share as if the fair value recognition provisions of
FAS No. 123 had been applied to all outstanding and unvested awards in the
prior year comparable period.
-8-
Three Months
Ended Nine Months Ended
September 30, 2005 September 30, 2005
---------------------- --------------------
Net loss, as reported $ (575,351) $(1,218,087)
Add: Stock based compensation included in
reported net income - -
Deduct: Total stock based compensation
expense determined under the fair value
based method for all awards (no tax effect) (49,553) (85,005)
---------------------- ------------------------
Pro forma net loss $ (624,904) $(1,303,092)
====================== ========================
Net loss per share:
Basic, as reported ($0.11) ($0.28)
Basic, proforma ($0.12) ($0.30)
Weighted Average Weighted Average
Exercise Price Per Remaining Aggregate Intrinsic
Number of Shares Share Contractual Term Value
------------------- ------------------ ------------------ ---------------------
Stock Options
Outstanding at December 31, 2005 1,788,500 $0.68
Granted 1,182,500 $0.86
Exercised
Forfeited/expired (50,000) $0.60
-------------------
Outstanding at September 30, 2006 2,921,000 $0.76 8.74 $1,051,357
===================
Vested and Exercisable at September 30, 2006 1,990,167 $0.68 7.00 $ 729,744
===================
-9-
As of September 30, 2006, there was $ 534,522 of total unrecognized
compensation costs related to unvested stock option awards which are expected
to vest over a weighted average life of .67 years.
Weighted
Average
Grant Date
Options Fair Value
----------- ----------
Nonvested at December 31, 2005 580,000 $0.50
Granted 1,182,500 $0.58
Vested (781,667 $0.57
Forfeited (50,000 $0.50
-----------
Nonvested at September 30, 2006 930,833 $0.57
===========
The total fair value of shares vested during the nine month period ended
September 30, 2006 was $418,591.
On June 2, 2006 the Company accelerated the vesting dates of 525,000 stock
options granted to certain officers and senior staff of the Company. The
Company also adopted an Executive Officer Compensation Plan, effective as of
June 2, 2006, in connection with a a purchase agreement for the sale of
4,724,999 shares of the Company's Common Stock to seventeen accredited
investors, with and pursuant to the letter agreements each officer agreed to
be bound by the Executive Officer Compensation Plan. In addition to the
conversion of accrued salary, the letter agreements provide for a reduction
by 25% in base salary for each officer and the granting of options to
purchase shares of Common Stock under the Company's 2003 Equity Participation
Plan which become exercisable upon the Company achieving certain revenue
milestones.
NOTE 5 - NOTES PAYABLE
On March 17, 2003, the Company commenced a private placement offering to
raise up to $250,000 in 6-month promissory notes in increments of $5,000
bearing interest at 15% per annum. Only selected investors which qualify as
"accredited investors" as defined in Rule 501(a) under the Securities Act of
1933, as amended, were eligible to purchase these promissory notes. The
Company raised the full $250,000 through the sale of such promissory notes,
resulting in net proceeds to the Company of $225,000, net of offering costs.
The notes contain a default provision which raises the interest rate to 20%
if the notes are not paid when due. As of June 30, 2006, $90,000 was
converted into 153,000 shares of the Company's Common Stock and $95,000 has
been repaid and the remaining balance of $65,000 was paid in full in
September, 2006.
In August 2004, the Company sold 30 day 20% notes in the amount of $55,000 to
two accredited investors to fund current operations. As of September 30,
2006, $30,000 of these notes has been paid and $25,000 converted into 42,500
shares of the Company's Common Stock. All interest payments have been paid
timely. In December 2004, the Company sold four notes to four accredited
investors totaling $100,000 with interest rates that range from 8% to 20%. As
of September 30, 2006, $15,000 has been repaid and $85,000 converted into
144,500 shares of the Company's Common Stock, and as of September 30, 2006
there are no amounts due. All interest payments have been made timely.
In March 2005, the Company sold a 30 day 8% note in the amount of $17,000, in
August 2005, an 8% note in the amount of $10,000 and in September 2005, two
8% notes in the amounts of $6,000 and $15,000 to its then President and then
CEO, totaling $48,000 and were all due on demand. In January 2006, all notes
were repaid. The interest on these notes was made timely.
-10-
On December 30, 2005, the Company sold $250,000 of convertible nine month
Promissory Notes which bear 9% simple interest with net proceeds to the
Company of $220,000. These convertible notes were sold in connection with a
subscription agreement between the Company and certain investors in which
Westpark Capital, Inc. ("Westpark") acted as the placement agent. (The
convertible notes and warrants sold in December, 2005 and January, 2006 in
the transaction in which Westpark acted as the placement agent is sometimes
referred to here in as the "Westpark Private Placement") The Company recorded
a debt discount associated with the conversion feature in the amount of
$83,333. For the three months and nine months ended September 30, 2006, the
Company charged $27,575 and $83,333 of the debt discount to interest expense,
respectively. The debt discount recorded of $83,333 does not change the
amount of cash required to pay off the principal value of these Promissory
Notes, at any time during the term, which was $250,000 as of June 30, 2006
and $50,000 as of October 31, 2006. As part of the Westpark Private
Placement, these Promissory Notes have 41,667 detachable warrants for each
$25,000 of debt, which entitle the holder to purchase one share of the
Company's Common Stock at a price of $1.20 per share. The warrants are
exercisable for a period of three years from the date of the Promissory Note.
In 2005, the Company recorded an expense of $2,573 associated with the
warrants as their fair value using the Black Scholes method. The Promissory
Notes convert to the Company's Common Stock at $.60 per share. The Promissory
Notes are convertible at any time into shares of Common Stock at the option
of the Company subsequent to the shares underlying the Promissory Notes and
the shares underlying the warrants registration if the closing price of the
Common Stock has been at least $1.80 for a period of at least 10 consecutive
days prior to the date on which notice of conversion is sent by the Company
to the holders of the Promissory Notes. Pursuant to the terms of the WestPark
Private Placement, the Company agreed to file with the SEC and have effective
by July 31, 2006, a registration statement registering the resale by the
Noteholders in the WestPark Private Placement of the shares of Common Stock
underlying the convertible notes and the warrants sold in the WestPark
Private Placement. This registration statement was not made effective by July
31, 2006 and certain additional rights have accrued to the Convertible
Promissory Noteholders. In connection with this event the Company approached
Convertible Promissory Noteholders with proposals to extend the term or
convert their debt positions into Common Stock under terms that are more
favorable than the subscription agreement calls for (below is a detailed
description of these proposals and the amount of debt that has been extended
or converted into Common Stock).
In January 2006, the Company sold an additional $250,000 of convertible nine
month Promissory Notes which bear 9% simple interest with net proceeds to the
Company of $223,880 as part of the Westpark Private Placement. The Company
recorded a debt discount associated with the conversion feature in the amount
of $129,167. For the three months and nine months ended September 30, 2006,
the Company charged $46,994 and $127,932 of the debt discount to interest
expense, respectively. The debt discount recorded of $129,167 does not change
the amount of cash required to pay off the principal value of these
Promissory Notes, at any time during the term, which was $250,000 at June 30,
2006 and $25,000 at October 31, 2006. These Promissory Notes also have 41,667
detachable warrants for each $25,000 of debt, which entitle the holder to
purchase one share of the Company's Common Stock at a price of $1.20 per
share. The warrants are exercisable for a period of three years from the date
of the Promissory Note. The Promissory Notes convert to the Company's Common
Stock at $.60 per share. The Promissory Notes are convertible at anytime into
shares of Common Stock at the option of the Company subsequent to the shares
underlying the Promissory Notes and the shares underlying the warrants
registration if the closing price of the Common Stock has been at least $1.80
for a period of at least 10 consecutive days prior to the date on which
notice of conversion is sent by the Company to the holders of the Promissory
Notes. Pursuant to the terms of the WestPark Private Placement, the Company
agreed to file with the SEC and have effective by July 31, 2006, a
registration statement registering the resale by the Noteholders in the
WestPark Private Placement of the shares of Common Stock underlying the
convertible notes and the warrants sold in the WestPark Private Placement.
This registration statement was not filed on July 31, 2006 and certain
additional rights have accrued to the Convertible Promissory Noteholders. In
connection with this event the Company approached Convertible Promissory
Noteholders with proposals to extend the term or convert their debt positions
into Common Stock under terms that are more favorable than the subscription
agreement calls for. On September, 2006 the Company filed with the SEC a
registration statement registering the resale by the Noteholders of the
WestPark Private Placement of the shares of Common Stock underlying the
convertible promissory notes and the warrants sold in the WestPark Private
Placement, this registration statement became effective on November 6, 2006.
-11-
Pursuant to the terms of the WestPark Private Placement, the Company agreed
to file with the SEC and have effective by July 31, 2006, a registration
statement registering the resale by the Noteholders in the WestPark Private
Placement of the shares of Common Stock underlying the convertible promissory
notes and the warrants sold in the WestPark Private Placement. In the event
the Company does not do so, (i) the conversion price of the convertible
promissory notes is reduced by 5% each month, subject to a floor of $.40;
(ii) the exercise price of the warrants is reduced by 5% each month, subject
to a floor of $1.00 and (iii) the warrants may be exercised pursuant to a
cashless exercise provision. The Company did not have the registration
statement effective by July 31, 2006 and requested that the Noteholders in
the WestPark Private Placement extend the date by which the registration
statement is required to be effective until February 28, 2007. The Company
also offered to the Noteholders the option of (A) extending the term of the
convertible note for an additional four months from the maturity date in
consideration for which (i) the Company shall issue to the Noteholder for
each $25,000 in principal amount of the convertible note 5,682 shares of
unregistered Common Stock; and (ii) the exercise price per warrant shall be
reduced from $1.20 to $.80, or (B) converting the convertible note into
shares of the Company's Common Stock in consideration for which (i) the
conversion price per conversion share shall be reduced to $.44; (ii) the
Company shall issue to the Noteholder for each $25,000 in principal amount of
the Note, 11,364 shares of Common Stock; (iii) the exercise price per warrant
shall be reduced from $1.20 to $.80; and (iv) a new warrant shall be issued
substantially on the same terms as the original Warrant to purchase an
additional 41,667 shares of Common Stock for each $25,000 in principal amount
of the convertible note at an exercise price of $.80 per share. Pursuant to
this, the Noteholder also was asked to waive any and all penalties and
liquidated damages accumulated as of the date of the agreement. This offer
was terminated on August 31, 2006. By August 31, 2006 Noteholders owning
$237,500 of the $500,000 of convertible promissory notes had agreed to
convert the convertible note into shares of the Company's Common Stock for
consideration described above and Noteholders holding $162,500 of the
$500,000 of convertible promissory notes had agreed to extend the term of the
convertible note for an additional four months from the maturity date for
consideration described above. The Company issued 539,772 shares of Common
Stock as the result of the conversion of $237,500 of convertible promissory
notes with a fair value of $275,568 and 107,954 shares of Common Stock as
consideration for early conversion of such notes with a fair value of
$55,115. In addition, the Company issued 395,833 warrants with a fair value
of $221,360 for Noteholders that agreed to an early conversion of their
convertible promissory notes. The Company also recorded a charge of $31,221
as the value associated with the repricing of warrants originally issued in
December, 2005. Amounts in excess of the face value of the convertible
promissory notes, the consideration tendered for early conversion of these
notes, the fair value of the warrants issued as the result of early
conversion and the repricing of warrants have been accounted for as interest
expense. The Company issued 36,932 shares of Common Stock as consideration
for extending the term of the convertible notes for an additional four months
with a fair value of $21,023. The fair value of this Common Stock has been
accounted for as interest expense.
In September, 2006 a new offer was extended to the remaining Noteholders to
convert the convertible note into shares of the Company's Common Stock in
consideration for which (i) the conversion price per conversion share shall
be reduced to $.44; (ii) the exercise price per warrant shall be reduced from
$1.20 to $.80 and (iii) a new warrant shall be issued substantially on the
same terms as the original Warrant to purchase an additional 41,667 shares of
Common Stock for each $25,000 in principal amount of the convertible note at
an exercise price of $.80 per share. Pursuant to this, the Noteholder was
asked to waive any and all penalties and liquidated damages accumulated as of
the date of the agreement. By September 30, 2006 Noteholders owning $125,000
convertible promissory notes agreed to convert the convertible note into
shares of the Company's Common Stock for consideration described above. The
Company issued 284,090 shares of Common Stock with a fair value of $232,954.
In addition, the Company issued 208,334 warrants with a fair value of $81,721
for Noteholders that agreed to an early conversion of their convertible
promissory notes. The Company also recorded a charge of $31,221 as the value
associated with the repricing of warrants originally issued in December,
2005. Amounts in excess of the face value of the convertible promissory
notes, the consideration tendered for early conversion of these notes, the
fair value of the warrants issued as the result of early conversion and the
repricing of warrants have been accounted for as interest expense.
In connection with the NS California acquisition, the Company assumed a 6%
note due to Tom Hirose, a former employee of NS California in the amount of
$15,812. As of September 30, 2006, $1,312 remains unpaid. Payments are made
in the amount of $1,500 per month and will continue until all amounts due
including interest are paid.
On May 17, 2006, the Company sold an 8% promissory note in the amount of
$20,000 due on demand to Robin Smith, the Company's then Chairman of the
Advisory Board. This promissory note was paid off on June 2, 2006.
The Company has financed certain insurance polices and has notes payable
balance due at September 30, 2006 of $78,654 related to these policies. These
notes require monthly payments and mature in less than one year.
-12-
NOTE 6 - SERIES "A" MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Certificate of Designations for the Company's Series A $.07 Convertible
Preferred Stock ("Series A Preferred Stock") provided that at any time after
December 1, 1999 any holder of Series A Preferred Stock may require the
Company to redeem his shares of Series A Preferred Stock (if there are funds
with which the Company may legally do so) at a price of $1.00 per share.
Notwithstanding the foregoing redemption provisions, if any dividends on the
Series A Preferred Stock are past due, no shares of Series A Preferred Stock
may be redeemed by the Company unless all outstanding shares of Series A
Preferred Stock are simultaneously redeemed. The holders of Series A
Preferred Stock may convert their Series A Preferred Stock into shares of
Common Stock of the Company at a price of $5.20 per share. On March 17, 2006,
the stockholders of the Company voted to approve an amendment to the
Certificate of Incorporation which permits the Company to issue in exchange
for all 681,171 shares of Series A Preferred Stock outstanding and its
obligation to pay $538,498 (or $.79 per share) in accrued dividends thereon,
a total of 544,937 shares of Common Stock (eight tenths (.8) shares of Common
Stock per share of Series A Preferred Stock). Pursuant thereto, at September
30, 2006, all outstanding shares of Series A Preferred Stock were cancelled
and converted into Common Stock. Therefore at September 30, 2006 and December
31, 2005, there were 0 and 68,117 shares of Series A Preferred Stock
outstanding.
NOTE 7 - STOCKHOLDERS' EQUITY
(a) Common Stock:
In January 2006, the Company issued 76,500 shares of its Common Stock in
exchange for $45,000 of notes payable. In addition, the Company issued 25,000
shares of its Common Stock to Westpark as additional compensation for its
role as placement agent in the Westpark Private Placement. The fair value of
these shares was $22,750 which was charged to expense. In connection with the
acquisition of certain assets of NeoStem, the Company issued 200,000 shares
of its Common Stock to NeoStem. An additional 200,000 shares of the Company's
Common Stock are being held in escrow pending any potential claims that may
be made in connection with the NeoStem transaction to be released one year
from the closing less any shares reclaimed due to amounts paid in cash in
lieu of stock. The Company issued 100,000 additional shares of its Common
Stock in escrow pending the approval of the license for the laboratory used
for the collection of stem cells. The agreement calls for 1,667 shares to be
forfeited each day the license is not obtained past February 15, 2006, with a
maximum of 100,000 shares of Common Stock subject to forfeiture. The license
was obtained in May, 2006 and therefore the Company has notified NeoStem of
the requirement that the 100,000 shares be forfeited to the Company.
Subsequent to the closing of the NeoStem transaction, the Company issued
201,223 shares of its Common Stock in payment of obligations assumed by the
Company. In certain cases, the Company issued shares with a fair market value
on the date of issuance of $98,600 which was greater than the debt being paid
and therefore recorded additional expense of $28,344.
In March 2006, the Company sold 60,227 shares of its Common Stock to five
accredited investors at a per share price of $.44 resulting in net proceeds
to the Company of $26,500.
In April and May 2006 the Company sold 351,319 shares of its Common Stock to
eleven accredited investors at a per share price of $.44 resulting in net
proceeds to the Company of $154,600
In May 2006, the Company entered into an advisory agreement with Duncan
Capital Group LLC ("Duncan"). Pursuant to the advisory agreement, Duncan is
providing to the Company on a non-exclusive "best efforts" basis, services as
a financial consultant in connection with any equity or debt financing,
merger, acquisition as well as with other financial matters. In return for
these services, the Company is paying to Duncan a monthly retainer fee of
$7,500, 50% of which may be paid by the Company in shares of its Common Stock
valued at fair market value and reimbursing it for its reasonable
out-of-pocket expenses in an amount not to exceed $12,000. Pursuant to the
advisory agreement, Duncan also agreed, subject to certain conditions, that
it or one of its affiliated entities would act as lead investor in a proposed
private placement (the "Duncan Private Placement") of shares of Common Stock
and warrants to purchase shares of Common Stock in an amount that is not less
than $2,000,000 or greater than $3,000,000. In consideration for such role,
Duncan received a fee of $200,000 in cash and 240,000 shares of restricted
Common Stock. On June 2, 2006, pursuant to the Duncan Private Placement, the
Company sold 4,724,999 shares of its Common Stock to seventeen accredited
investors at a per share price of $.44 resulting in gross proceeds of $
2,079,000, In connection with this transaction the Company issued 2,362,499
common stock purchase warrants to these seventeen investors. These Common
Stock purchase warrants have a term of 5 years and exercise price of $.80 per
share. From the proceeds of sale of Common Stock a fee of $200,000 was paid
to Duncan and 240,000 Common shares were issued to Duncan. In addition Dr.
Robin Smith was paid a fee of $100,000 and 100,000 Common shares were issued
to her in connection with an Advisory Agreement dated September 14, 2005 as
amended by the Supplement to Advisory Agreement dated January 18, 2006 and
Dr. Smith's employment agreement with the Company dated June 2, 2006.
-13-
On June 2, 2006 certain employees and members of senior management agreed to
take common stock as the net pay on $278,653 of unpaid salary that dated back
to 2005. This resulted in the issuances of 379,982 shares of common stock,
valued at $167,192, or $.44 per share, the balance of the unpaid salary was
used to pay the withholding taxes which are associated with those earnings.
On June 2, 2006 Dr. Robin Smith was appointed Chairman and CEO of the
Company. In connection with Dr. Smith's appointment 200,000 shares of common
stock were issued to Dr. Smith valued at $88,000 which was reflected as
compensation expense in the three months ended June 30, 2006. In addition,
Dr. Smith was granted common stock options to purchase 540,000 shares of the
Company's common stock, which 300,000 option shares vested immediately,
120,000 option shares vest on the first anniversary of the effective date and
120,000 option shares vest on the second anniversary of the effective date.
The exercise price of the options are (i) $.53 as to the first 100,000 option
shares, (ii) $.80 as to the second 100,000 option shares, (iii) $1.00 as to
the third 100,000 option shares, (iv) $1.60 as to the next 120,000 option
shares, and (v) $2.50 as to the balance.
In July and August 2006, the Company sold an aggregate of 3,977,273 shares of
Common Stock to 34 accredited investors at a per share price of $.44
resulting in gross proceeds to the Company of $1,750,000. In July and August
2006, the Company issued an aggregate of 83,405 shares of Common Stock in
conversion of an aggregate of $40,657 in accounts payable owed to certain
vendors. The per share conversion price ranged from $.44 to $.56. In
addition, in August 2006, the Company issued 131,759 shares of Common Stock
in payment for services rendered equal to $77,840, at a per share price of
$.59.
In July and August 2006, in connection with the offer to Noteholders for
early conversion of the Convertible Promissory Notes of the WestPark Private
Placement, the Company issued 539,772 shares of Common Stock at a per share
price of $.51 and 107,954 shares of Common Stock as consideration for early
conversion of such notes with a per share price of $.51
In July 2006, in connection with the offer to Noteholders for the extension
of due dates of the Convertible Promissory Notes of the WestPark Private
Placement, the Company issued 36,932 shares of Common Stock with a per share
price of $.57.
In September 2006, in connection with the offer to Noteholders for early
conversion of the Convertible Promissory Notes of the WestPark Private
Placement, the Company issued 284,090 shares of Common Stock with a per share
price of $.82.
(b) Warrants:
The Company has issued Common Stock purchase warrants from time to time to
investors in private placements, certain vendors, underwriters, and directors
and officers of the Company. A total of 6,117,219 shares of Common Stock are
reserved for issuance upon exercise of outstanding warrants as of September
30, 2006 at prices ranging from $0.50 to $1.20 and expiring through September
2011. In connection with the September 2003 equity private placement, the
Company issued a 5 year warrant to purchase 28,250 shares of its Common Stock
at an exercise price of $1.20 per share to its retained placement agent,
Robert M. Cohen & Company. The warrant contains piggyback registration
rights. From August 2004 through January 20, 2005, the Company issued three
year warrants to purchase a total of 15,000 shares of its Common Stock at
$.50 per share to Consulting For Strategic Growth, Ltd., the Company's
investor relations firm. On September 14, 2005, the Company issued 24,000
Common Stock purchase warrants to its then Chairman of its Advisory Board,
Dr. Robin Smith. These warrants were scheduled to vest at the rate of 2,000
per month beginning with September 14, 2005. The vesting of these warrants
was accelerated so that they became immediately vested on June 2, 2006
pursuant to Dr. Smith's employment agreement. Each warrant entitles the
holder to purchase one share of the Company's Common Stock at a price of $.80
per share. The warrant expires three years from issuance. In December 2005
and January 2006, the Company issued an aggregate of 458,333 Common Stock
purchase warrants, in each period, to the investors and placement agent. Each
warrant entitles the holder to purchase one share of Common Stock at a price
of $1.20 per share for a period of three years. In March 2006, the Company
issued 12,000 Common Stock purchase warrants to Healthways Communications,
Inc., the Company's marketing consultants. These warrants vest 2,000 per
month beginning March 2006 and entitle the holder to purchase one share of
Common Stock at a price of $1.00 per share for a period of three years. In
2006 the Healthways Communications, Inc. agreement was terminated and 4,000
Common Stock purchase warrants issued to Healthways Communications, Inc. were
cancelled. On June 2, 2006, pursuant to the Duncan Private Placement, the
Company sold 4,724,999 shares of its Common Stock to seventeen accredited
investors at a per share price of $.44 resulting in gross proceeds of
$2,079,000, In connection with this transaction the Company issued 2,362,499
common stock purchase warrants to these seventeen investors. These common
stock purchase warrants have a term of 5 years and exercise price of $.80 per
share.
-14-
In connection with the July and August sale of common stock to 34 accredited
investors the Company issued 1,988,637 Common Stock purchase warrants with a
term of five years and per share exercise price of $.80.
In July and August, 2006, in connection with the offer to Noteholders for
early conversion of the Convertible Promissory Notes of the WestPark Private
Placement, the Company issued 395,833 warrants. These common stock purchase
warrants have a term of three years and exercise price of $.80 per share.
In August, 2006, the Company issued warrants to purchase an aggregate of
170,000 shares of Common Stock at $0.80 per share to four persons under
advisory agreements. Such warrants are each exercisable for three years from
the date of issue.
In September, 2006, in connection with the offer to Noteholders for early
conversion of the Convertible Promissory Notes of the WestPark Private
Placement, the Company issued 208,334 warrants. These common stock purchase
warrants have a term of three years and exercise price of $.80 per share.
(c) Stock Option Plans:
In February 2003, the Company adopted the 2003 Equity Participation Plan,
which was approved by stockholders at the Company's Annual Meeting on July
24, 2003 and amended by approval of stockholders at the Company's Annual
Meeting on July 20, 2005 and further amended by the Board of Directors on
October 10, 2006. Under this plan, the Company has reserved 25,000,000 shares
of common stock for the grant of incentive stock options and non-statutory
stock options to employees and non-employee directors, consultants and
advisors.
Information with respect to options under the 2003 Equity Participation Plan
is summarized as follows:
For the Three Months Ended For the Nine Months Ended
September 30, 2006 September 30, 2006
------------------------------------- ------------------------------------------
Shares Prices Shares Prices
----------------- ---------------- -------------------- ------------------
Outstanding at beginning of period 2,875,000 $0.30 to $2.50 1,788,500 $0.30 to $1.80
Granted 46,000 $0.44 to $.60 1,182,500 $0.44 to $2.50
Expired - - - -
Cancelled - (50,000) $0.60
----------------- ----------------
Outstanding at end of period 2,921,000 $0.30 to $2.50 2,921,000 $0.30 to $2.50
================= ================
Options are usually granted at an exercise price at least equal to the fair
value of the common stock at the grant date and may be granted to employees,
Directors, consultants and advisors of the Company.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
On January 20, 2006, Mr. Robert Aholt, Jr. tendered his resignation as Chief
Operating Officer of the Company. In connection therewith, on March 31, 2006,
the Company and Mr. Aholt entered into a Settlement Agreement and General
Release (the "Settlement Agreement"). Pursuant to the Settlement Agreement,
the Company agreed to pay to Mr. Aholt the aggregate sum of $250,000 (less
applicable Federal and California state and local withholdings and payroll
deductions), payable over a period of two years in biweekly installments of
$4,807.69 commencing on April 7, 2006, except that the first payment was in
the amount of $9,615,38. In the event the Company breaches its payment
obligations under the Settlement Agreement and such breach remains uncured,
the full balance owed shall become due. The Company and Mr. Aholt each
provided certain general releases. Mr. Aholt also agreed to continue to be
bound by his obligations not to compete with the Company and to maintain the
confidentiality of Company proprietary information. At September 30, 2006
$175,581 was due Mr. Aholt pursuant to the terms of the Settlement Agreement.
In connection with the Company's acquisition of the assets of NeoStem on
January 19, 2006, the Company entered into an employment agreement with Larry
A. May. Mr. May is the former Chief Executive Officer of NS California.
Pursuant to Mr. May's employment agreement, he is to serve as an officer of
the Company reporting to the CEO for a term of three years, subject to
earlier termination as provided in the agreement. In return, Mr. May will be
paid an annual salary of $165,000, payable in accordance with the Company's
standard payroll practices, will be entitled to participate in the Company's
benefit plans generally available to other executives, including a car
allowance equal to $750 per month and was granted on his commencement date an
employee stock option under the Company's 2003 Equity Participation Plan to
purchase 15,000 shares of the Company's Common Stock at a per share purchase
price equal to $.50, the closing price of the Common Stock on the
commencement date, which vests as to 5,000 shares of Common Stock on the
first, second and third anniversaries of the commencement date. Under certain
circumstances, Mr. May is also entitled to a severance payment equal to one
year's salary in the event of the early termination of his employment.
-15-
In connection with the Company's acquisition of the assets of NS California
on January 19, 2006, the Company entered into an employment agreement with
Denis O. Rodgerson. Dr. Rodgerson is one of the founders of NeoStem. Dr.
Rodgerson's employment agreement is identical to Mr. May's employment
agreement, except that (i) its term is one year; (ii) he was granted an
option to purchase 5,000 shares of Common Stock under the Equity
Participation Plan vesting in its entirety after one year; and (iii) his
agreement does not contain a provision for severance.
Certain employees and members of senior management of the Company, as a
condition of the initial closing under the Securities Purchase Agreement in
the Duncan Private Placement, entered into letter agreements with the Company
pursuant to which they converted an aggregate of $278,653 of accrued salary
into shares of Common Stock at a per share price of $0.44. After adjustments
for applicable payroll and withholding taxes which were paid by the Company,
the Company issued to such individuals an aggregate of 379,982 shares of
Common Stock. The Company also adopted a Compensation Plan, effective as of
the date of closing of the Securities Purchase Agreement and pursuant to the
letter agreements each officer agreed to be bound by the Compensation Plan.
In addition to the conversion of accrued salary, the letter agreements
provide for a reduction by 25% in base salary for each officer until the
Company achieves certain milestones, the granting of options to purchase
shares of Common Stock under the Company's 2003 Equity Participation Plan
(the "2003 EPP") which become exercisable upon the Company achieving certain
revenue milestones and the acceleration of the vesting of certain options and
restricted shares held by the officers.
On May 26, 2006, the Company entered into an employment agreement with Dr.
Robin L. Smith (the "Employment Agreement"), pursuant to which Dr. Smith will
serve as the Chief Executive Officer of the Company for a period of two
years, which term shall be renewed for successive one-year terms unless
otherwise terminated by Dr. Smith or the Company. The effective date of the
Employment Agreement was June 2, 2006, the date of the initial closing under
the Duncan Private Placement. Dr. Smith shall receive a base salary of
$180,000 per year, which shall be increased to $236,000 after the first year
anniversary of the effective date of the Employment Agreement. If the Company
raises an aggregate of $5,000,000 through equity or debt financing (with the
exception of the financing under the Duncan Private Placement), Dr. Smith's
base salary shall be raised to $275,000. Dr. Smith shall also be eligible for
an annual bonus determined by the Board, a car allowance of $1,000 per month
and variable life insurance with payments not to exceed $1,200 per month.
Pursuant to the Employment Agreement, Dr. Smith's advisory agreement with the
Company, as supplemented, was terminated, except that (i) the vesting of the
warrant to purchase 24,000 shares of Common Stock granted there under was
accelerated so that the warrant became fully vested as of the effective date
of the employment agreement, (ii) Dr. Smith received $100,000 in cash and
100,000 shares upon the initial closing of the Duncan Private Placement,
(iii) if an aggregate of at least $3,000,000 is raised and/or other debt or
equity financings prior to August 15, 2006, Dr. Smith shall receive an
additional payment of $50,000, (iv) a final payment of $3,000 relating to
services rendered in connection with Dr. Smith's advisory agreement, was paid
at the closing of the Duncan Private Placement and (v) all registration
rights provided in the advisory agreement shall continue in effect. Upon the
effective date of the Employment Agreement, Dr. Smith was awarded under the
Company's 2003 Equity Participation Plan 200,000 shares of Common Stock of
the Company, and options to purchase 540,000 shares of Common Stock, which
options expire ten years from the date of grant. On August 30, 2006, the
milestone set forth in (iii) was achieved. Dr. Smith elected to have $30,000
of this amount distributed to certain employees of the Company including its
Chief Financial Officer and General Counsel in recognition of their efforts
on behalf of the Company. Dr Smith was paid the remaining $20,000.
-16-
NOTE 9 - ACQUISITION OF NS CALIFORNIA
On January 19, 2006 the Company consummated the acquisition of the assets of
NS California Inc.,("NS California")relating to NS California's business of
collecting and storing adult stem cells, issuing 400,000 shares of the
Company's Common Stock with a value of $200,000. In addition, the Company
assumed certain liabilities of NS California which totaled $476,972. The
underlying physical assets acquired from NS California were valued at
$109,123 resulting in the recognition of goodwill in the amount of $558,169.
Upon completion of the acquisition the operations of NS California were
assumed by Phase III and have been reflected in the Statement of Operations
since January 19, 2006. Effective with the acquisition, the business of NS
California became the principal business of the Company. The Company provides
adult stem cell processing, collection and banking services with the goal of
making stem cell collection and storage widely available, so that the general
population will have the opportunity to store their own stem cells for future
healthcare needs. Presented below is the proforma information for the three
and nine months ended September 30, 2006 and 2005 as if the acquisition had
occurred on January 1, 2005. The net loss per share for the three and nine
months ended September 30, 2006 gives effect to the shares issued in
connection with the acquisition.
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------- ---------------------------------------------
2006 2005 2006 2005
-------------------- ------------------- -------------------- ---------------------
Revenue $ 6,262 $ 8,218 $ 18,786 $ 28,201
Net loss ($1,807,307) ($830,130) ($4,193,196) ($2,483,852)
Net loss per share ($0.11) ($0.16) ($0.36) ($0.57)
NOTE 10 - RELATED PARTIES
In connection with the acquisition of NS California, an officer and an
employee of the Company, who were then officers of NS California, received
Common Stock in payment of liabilities assumed by the Company. Larry May,
Chief Financial Officer and Denis Rodgerson, Director of Stem Cell Science,
received shares of Common Stock in excess of the value of the liability
assumed by the Company. In the case of Mr. May, he received 9,615 shares of
Common Stock valued at $4,807 in settlement of a liability assumed by the
Company of $2,884. The Company recorded an additional expense of $1,923. In
the case of Dr. Rodgerson, he received 67,523 shares of Common Stock valued
at $33,761 in settlement of a liability assumed by the Company of $20,257.
The Company recorded an additional expense of $13,504.
NOTE 11 - INDUSTRY AND GEOGRAPHICAL SEGMENTAL INFORMATION
On January 19, 2006, the Company acquired substantially all the assets and
operations of NS California, an adult stem cell collection and banking
Company. The Company, with this acquisition, will have operations in two
segments when NeoStem commences operations. One segment will be the
collection and banking of adult stem cells and the other segment remains the
"run off" of its sale of extended warranties and service contracts via the
Internet, this "run-off" of warranty and service contracts will continue for
approximately seven months. As of September 30, 2006, the Company has not
realized any revenues from the collecting or banking of adult stem cells. The
Company's operations are conducted entirely in the United States. The Company
has a "run off" of extended warranties and service contracts which generated
a profit for the three months and nine months ended September 30, 2006 of
$1,795 and $3,585, respectively.
NOTE 12 - SUBSEQUENT EVENTS
In September, 2006 an offer was extended to the Noteholders of the WestPark
Private Placement to convert the convertible note into shares of the
Company's Common Stock in consideration for which (i) the conversion price
per conversion share shall be reduced to $.44; (ii) the exercise price per
warrant shall be reduced from $1.20 to $.80 and (iii) a new warrant shall be
issued substantially on the same terms as the original Warrant to purchase an
additional 41,667 shares of Common Stock for each $25,000 in principal amount
of the convertible note at an exercise price of $.80 per share. Pursuant to
this, the Noteholders were also asked to waive any and all penalties and
liquidated damages accumulated as of the date of the agreement. By September
30, 2006 Noteholders owning $125,000 convertible promissory notes agreed to
convert the convertible notes into shares of the Company's Common Stock for
consideration described above. In October, 2006 Noteholders owning $62,500
convertible promissory notes agreed to convert the convertible note into
shares of the Company's Common Stock for consideration described above.
-17-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q and the documents incorporated herein
contain "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may
cause the actual results, performance or achievements of the Company, or
industry results, to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. When used in this Quarterly 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. Forward
looking statements may not be realized due to a variety of factors, including
but not limited to, the Risk Factors described in Part II, Item 1a of this
Report and in our annual report on Form 10-K filed with the Securities and
Exchange Commission. All forward looking statements are qualified in their
entirety by this cautionary note. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
hereof. 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.
GENERAL
On January 19, 2006 the Company consummated the acquisition of the assets of
NS California Inc., a California corporation ("NS California") relating to NS
California's business of collecting and storing adult stem cells. NS
California had been a company to which NeoStem had been providing business
guidance. Effective with the acquisition, the business of NS California
became the principal business of the Company. The Company now provides adult
stem cell processing, collection and banking services with the goal of making
stem cell collection and storage widely available, so that the general
population will have the opportunity to store their own stem cells for future
healthcare needs. The Company also hopes to become the leading provider of
adult stem cells for therapeutic use in the burgeoning field of regenerative
medicine for potentially addressing heart disease, certain types of cancer
and other critical health problems. The Company is utilizing the combined
NeoStem and NS California management teams to develop and expand this
business.
Until the NS California acquisition, the business of the Company was
providing capital and business guidance to companies in the healthcare and
life science industries, in return for a percentage of revenues, royalty
fees, licensing fees and other product sales of the target companies.
Additionally, through September 30, 2002, the Company was a provider of
extended warranties and service contracts via the Internet at
warrantysuperstore.com. The Company is still engaged in the "run off" of such
extended warranties and service contracts.
RESULTS OF OPERATIONS
The Company recognizes revenue from its warranty service contracts business
over the life of contracts executed. Additionally, the Company purchased
insurance to fully cover any losses under the service contracts from a
domestic carrier. The insurance premium expense and other costs related to
the sale are amortized ratably over the life of the contracts.
-18-
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 2005
The Company recognized revenues from the sale of extended warranties and
service contracts via the Internet of $6,262 and $18,786 for the three months
and nine months ended September 30, 2006, respectively, as compared to $8,218
and $28,201 for the three months and nine months ended September 30, 2005,
respectively. The revenues generated in the quarter were derived entirely
from revenues deferred over the life of contracts sold in prior periods.
Warranty revenue will continue to decline as policy periods expire since the
Company is no longer selling extended warranty contracts. It is expected that
the recognition of Warranty revenue will end in approximately seven months.
As of September 30, 2006, the Company has not realized any revenues from the
NS California acquisition. It is anticipated that limited revenues will begin
in 2006. Similarly, direct costs incurred, in connection with the extended
warranty contracts, were $4,467 and $13,401 for the three and nine months
ended September 30, 2006 respectively as compared to $5,750 and $19,770 for
the three months and nine months ended September 30, 2005, respectively.
Selling, general and administration expenses increased approximately $461,755
and $1,866,394 for the three and nine months ended September 30, 2006 as
compared to the three and nine months ended September 30, 2005. The increase
in selling, general and administrative expenses for the three months ended
September 30, 2006 is primarily due to increases in payroll and related
expenses of $60,879, for increase in staff as the result of acquiring NS
California, legal expense of $85.978, the compensatory element of stock
options issued to staff members in the amount of $76.392, accounting fees of
$4,360, rent of $42,734, marketing expenses of $51,659, travel and
entertainment of $29,989, website development $45,000, consulting fees of
$47,365 and insurance primarily related to NeoStem of $24,848. The increase
in selling, general and administrative expenses for the nine months ended
September 30, 2006 compared to the nine months ended September 30, 2005, is
primarily due to increases in payroll and related expenses of $285,783, for
increase in staff as the result of acquiring NS California, legal expense of
$211,714, and the compensatory element of stock options issued to staff
members and common stock issued as a signing bonus paid to Dr. Robin Smith
upon being appointed Chairman of the Board and Chief Executive Officer in the
amount of $462,908 the settlement with Robert Aholt of $250,000, investment
banking consulting of $120,565 insurance primarily related to the Company's
new business of $114,942, marketing relating to the Company's new business of
$93,396, rent of $67,002, laboratory related expenses of $43,024, consulting
fees of $56,792, stock transfer fees of $36,744, website development of
$49,638 and travel and entertainment of $58,361 relating to the Company's
efforts to develop it new business.
Interest expense increased approximately $792,885 and $1,146,241 for the
three and nine months ended September 30, 2006 as compared to the three and
nine months ended September 30, 2005. The increase in interest expense for
the three months ended September 30, 2006 is primarily due to the early
conversion of the WestPark Convertible Promissory Notes issued in December,
2005 and January, 2006. In July, The Company offered to WestPark Noteholders
the option of (A) extending the term of the convertible note for an
additional four months from the maturity date in consideration for which (i)
the Company shall issue to the investor for each $25,000 in principal amount
of the convertible note 5,682 shares of unregistered Common Stock; and (ii)
the exercise price per warrant shall be reduced from $1.20 to $.80, or (B)
converting the convertible note into shares of the Company's Common Stock in
consideration for which (i) the conversion price per conversion share shall
be reduced to $.44; (ii) the Company shall issue to the investor for each
$25,000 in principal amount of the Note, 11,364 shares of Common Stock; (iii)
the exercise price per warrant shall be reduced from $1.20 to $.80; and (iv)
a new warrant shall be issued substantially on the same terms as the original
Warrant to purchase an additional 41,667 shares of Common Stock for each
$25,000 in principal amount of the convertible note at an exercise price of
$.80 per share. This offer was terminated on August 31, 2006. The Company
issued 539,772 shares of Common Stock as the result of the conversion of
$237,500 of convertible promissory notes with a fair value of $275,568 and
107,954 shares of Common Stock as consideration for early conversion of such
notes with a fair value of $55,115. In addition, the Company issued 395,833
warrants with a fair value of $221,360 for Noteholders that agreed to an
early conversion of their convertible promissory notes. The Company also
recorded a charge of $31,221 as the value associated with the repricing of
warrants originally issued in December, 2005. Amounts in excess of the face
value of the convertible promissory notes, the consideration tendered for
early conversion of these notes, the fair value of the warrants issued as the
result of early conversion and the repricing of warrants have been accounted
for as interest expense. The Company issued 36,932 shares of Common Stock as
consideration for extending the term of the convertible notes for an
additional four months with a fair value of $21,023. In September, 2006 a new
offer was extended to the remaining Noteholders to convert the convertible
note into shares of the Company's Common Stock in consideration for which (i)
the conversion price per conversion share shall be reduced to $.44; (ii) the
exercise price per warrant shall be reduced from $1.20 to $.80 and (iii) a
new warrant shall be issued substantially on the same terms as the original
Warrant to purchase an additional 41,667 shares of Common Stock for each
$25,000 in principal amount of the convertible note at an exercise price of
$.80 per share. By September 30, 2006 investors owning $125,000 convertible
promissory notes agreed to convert the convertible note into shares of the
Company's Common Stock for consideration described above. The Company issued
284,090 shares of Common Stock with a fair value of $232,954. In addition,
the Company issued 208,334 warrants with a fair value of $81,721 for
Noteholders that agreed to an early conversion of their convertible
promissory notes. The Company also recorded a charge of $31,221 as the value
associated with the repricing of warrants originally issued in December,
2005. These transactions resulted in interest expense of $727,894. The
increase in interest expense for the nine months ended September 30, 2006 is
also primarily due to the early conversion of the WestPark Convertible
Promissory Notes issued in December, 2005 and January, 2006 and accounts for
$727,894 of the increase in interest expense for the nine months. In
addition, the remainder of the increase was the result of debt discount,
warrants issued and interest payments associated with the WestPark
Convertible Promissory Notes of $438,364. These increases in interest expense
were offset by reductions in interest expense related to the repayment of
other debt; and the conversion of Series A Preferred Shares to Common Stock.
-19-
For the reasons cited above the net loss for the three and nine months ended
September 30, 2006 of $1,807,307 and $4,193,956 increased over the net loss
of $575,351 and $1,218,087 for the three and nine months ended September 30,
2005.
LIQUIDITY AND CAPITAL RESOURCES
The following chart represents the net funds provided by or used in
operating, financing and investment activities for each period indicated:
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, SEPTEMBER 30,
2006 2005
---- ----
Cash used in
Operating Activities $ (2,867,684) $ (477,491)
Cash (used) provided by
Investing Activities $ (13,073) $ -
Cash provided by
Financing Activities $ 3,712,370 $ 460,000
While the Company incurred a net loss of $4,193,956 for the nine months ended
September 30, 2006 this loss resulted in uses of cash of $2,867,684. The
large difference between operating loss and cash used in operations was the
result of a number of non-cash expenses charged to results of operations
including; common stock, option and warrant issuances and warrant repricing
which were related to services rendered and interest of $1,583,923,
amortization and depreciation of $230,224 and interest related to the Series
A Preferred of $9,934 which was offset by cash settlements of various
accounts payable, notes payable and accrued liabilities of $429,694. Uses of
cash for operations also included additions to prepaid expenses and other
current assets of $61,049.
To meet its cash requirement for the nine months ended September 30, 2006,
the Company relied on proceeds from the sale of $250,000 of convertible notes
and the sale of shares of Common Stock resulting in net proceeds of
$3,573,068.
In July, August and September, 2006 the Company took steps to improve its
financial position relative to outstanding debt. To that end in July, the
Company offered to WestPark Noteholders the option of (A) extending the term
of the convertible note for an additional four months from the maturity date
in consideration for which (i) the Company shall issue to the investor for
each $25,000 in principal amount of the convertible note 5,682 shares of
unregistered Common Stock; and (ii) the exercise price per warrant shall be
reduced from $1.20 to $.80, or (B) converting the convertible note into
shares of the Company's Common Stock in consideration for which (i) the
conversion price per conversion share shall be reduced to $.44; (ii) the
Company shall issue to the investor for each $25,000 in principal amount of
the Note, 11,364 shares of Common Stock; (iii) the exercise price per warrant
shall be reduced from $1.20 to $.80; and (iv) a new warrant shall be issued
substantially on the same terms as the original Warrant to purchase an
additional 41,667 shares of Common Stock for each $25,000 in principal amount
of the convertible note at an exercise price of $.80 per share. This offer
was terminated on August 31, 2006. This offer resulted in the conversion of
$237,500 of the $500,000 convertible promissory notes to common stock. In
addition, Noteholders of $162,500 of convertible notes agreed to extend the
due of their notes an additional four months from the maturity date. In
September, 2006 a new offer was extended to the remaining Noteholders to
convert the convertible note into shares of the Company's Common Stock in
consideration for which (i) the conversion price per conversion share shall
be reduced to $.44; (ii) the exercise price per warrant shall be reduced from
$1.20 to $.80 and (iii) a new warrant shall be issued substantially on the
same terms as the original Warrant to purchase an additional 41,667 shares of
Common Stock for each $25,000 in principal amount of the convertible note at
an exercise price of $.80 per share. This offer resulted in the conversion of
$125,000 of the $500,000 convertible promissory notes to common stock. In
October, 2006 Noteholders owning $62,500 convertible promissory notes agreed
to convert the convertible note into shares of the Company's Common Stock. As
of October 31, 2006 there were only $75,000 of the WestPark Convertible
Promissory Note outstanding, due in February, 2007. The Company's financial
statements have been prepared assuming the Company will continue as a going
concern. The Company currently has no operations and limited financial
resources to pay its current expenses and liabilities. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
-20-
INFLATION
The Company does not believe that its operations have been materially
influenced by inflation for the nine months ended September 30, 2006, a
situation which is expected to continue for the foreseeable future.
-21-
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable
ITEM 4. CONTROLS AND PROCEDURES
(a) During the three month period ended September 30, 2006, our management,
including the principal executive officer and principal financial officer,
evaluated our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) related
to the recording, processing, summarization and reporting of information in
our reports that we file with the SEC. These disclosure controls and
procedures have been designed to ensure that material information relating
to us, including our subsidiaries, is made known to our management,
including these officers, by other of our employees, and that this
information is recorded, processed, summarized, evaluated and recorded as
applicable, within the time periods specified in the SEC rules and forms.
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 that 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 the management override of the control. Our controls and
procedures can only provide reasonable, not absolute, assurance that the
above objectives have been met.
(b) Based on their evaluation as of September 30, 2006, our principal
executive officer and principal financial officer have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are effective to
reasonably ensure that the information required to be disclosed by us in
the reports that we file or submit under the Securities Exchange Act of
1934 is recorded, processed, summarized, and recorded within the time
periods specified in the SEC rules and forms
-22-
PHASE III MEDICAL, INC.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 1A. RISK FACTORS
SALES OF SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK IN THE OPEN MARKET, OR THE
AVAILABILITY OF SUCH SHARES FOR SALE, COULD ADVERSELY AFFECT THE PRICE OF OUR
COMMON STOCK.
We had 19,636,799 shares of Common Stock outstanding as of November 13, 2006.
The following securities that may be exercised for, or are convertible into,
shares of our Common Stock were issued and outstanding as of November 13,
2006:
o Options. Stock options to purchase 3,100,998 shares of our Common Stock at
a weighted average exercise price of approximately $.76 per share.
o Warrants. Warrants to 6,221,387 shares of our Common Stock at a weighted
average exercise price of approximately $.91 per share.
o Convertible Promissory Notes. Notes which will convert into 125,000 shares
of our Common Stock.
All the shares of our Common Stock that may be issued under the options,
warrants and convertible promissory notes are currently registered for resale
with the SEC.
WE HAVE LIQUIDITY PROBLEMS AND OUR ABILITY TO CONTINUE AS A GOING CONCERN IS
UNCERTAIN, WHICH MAY AFFECT OUR ABILITY TO RAISE CAPITAL.
At September 30, 2006, we had a cash balance of $1,320,486 and working
capital of $851,135. Our auditors, Holtz Rubenstein Reminick LLP, have
expressed substantial doubt about our ability to continue as a going concern
based on our lack of liquidity combined with our history of losses, and it
will be more difficult for us to raise capital on favorable terms as a
result. Our financial statements do not reflect any adjustments relating to
the doubt of our ability to continue as a going concern. We have from time to
time raised capital for our activities through the sale of our equity
securities and promissory notes. Such capital raising activities are enabling
us to pursue our business plan and grow our adult stem cell collection and
storage business, including expanding marketing and sales activities as well
as pay certain of our outstanding liabilities. Our financial condition still
raises substantial doubt about our ability to operate as a going concern.
Substantial additional financing is needed.
WE MAY BE FORCED TO UNDERTAKE LENGTHY AND COSTLY EFFORTS TO BUILD MARKET
ACCEPTANCE OF OUR STEM CELL STORAGE SERVICES, THE SUCCESS OF WHICH IS
CRITICAL TO OUR PROFITABILITY. THERE CAN BE NO ASSURANCE THAT THESE SERVICES
WILL GAIN MARKET ACCEPTANCE.
We anticipate that service fees from the processing and storage of stem cells
will comprise a substantial majority of our revenue in the future and,
therefore, our future success depends on the successful and continued market
acceptance of this service. Broad use and acceptance of our service requires
marketing expenditures and education and awareness of consumers and medical
practitioners who, under present law, must order stem cell collection on
behalf of a potential customer. The time and expense required to educate and
build awareness of our services and its potential benefits could
significantly delay market acceptance and our ultimate profitability. The
successful commercialization of our services will also require that we
satisfactorily address the concerns of medical practitioners in order to
avoid potential resistance to recommendations for our services and ultimately
reach our potential consumers. No assurances can be given that our business
plan and marketing efforts will be successful, that we will be able to
commercialize our services, or that there will be market acceptance of our
services or clinical acceptance of our services by physicians sufficient to
generate any material revenues for us.
-23-
ETHICAL AND OTHER CONCERNS SURROUNDING THE USE OF STEM CELL THERAPY MAY
INCREASE THE REGULATION OF OR NEGATIVELY IMPACT THE PUBLIC PERCEPTION OF OUR
STEM CELL BANKING SERVICES, THEREBY REDUCING DEMAND FOR OUR SERVICES.
The use of embryonic stem cells for research and stem cell therapy has been
the subject of debate regarding related ethical, legal and social issues.
Although our business only utilizes adult stem cells and does not involve the
more controversial use of embryonic stem cells, the use of other types of
human stem cells for therapy could give rise to similar ethical, legal and
social issues as those associated with embryonic stem cells. Additionally, it
is possible that our business could be negatively impacted by any stigma
associated with the use of embryonic stem cells if the public fails to
appreciate the distinction between the use of adult versus embryonic stem
cells. The commercial success of our business will depend in part on public
acceptance of the use of stem cell therapy, in general, for the prevention or
treatment of human diseases. Public attitudes may be influenced by claims
that stem cell therapy is unsafe or unnecessary, and stem cell therapy may
not gain the acceptance of the public or the medical community. Public
pressure or adverse events in the field of stem cell therapy that may occur
in the future also may result in greater governmental regulation of our
business creating increased expenses and potential regulatory delays relating
to the approval or licensing of any or all of the processes and facilities
involved in our stem cell banking services. In the event that the use of stem
cell therapy becomes the subject of adverse commentary or publicity, our
business could be adversely affected and the market price for our common
stock could be significantly harmed.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT, AND OUR FAILURE TO COMPLY WITH
APPLICABLE REGULATIONS, REGISTRATIONS AND APPROVALS WOULD MATERIALLY AND
ADVERSELY AFFECT OUR BUSINESS.
Historically, the FDA has not regulated banks that collect and store stem
cells. Recent changes, however, require establishments engaged in the
recovery, processing, storage, labeling, packaging or distribution of any
Human Cells, Tissues, and Cellular and Tissue-Based Products (HCT/Ps) or the
screening or testing of a cell tissue donor to register with the FDA under
the Public Health Service Act as of January 2004. The FDA also adopted rules
in May 2005 that regulate current Good Tissues Practices (cGTP). We may be or
become subject to such registration requirements and regulations, and there
can be no assurance that we will be able, or will have the resources, to
comply. Future FDA regulations could also adversely impact or limit our
ability to market or perform our services. In order to collect and store
blood stem cells we must conduct (or arrange for the conduct of) a variety of
laboratory tests which are regulated under the federal Clinical Laboratory
Improvements Amendments (CLIA). Any facility conducting regulated tests must
obtain a CLIA certificate of compliance and submit to regular inspection.
Some states require additional regulation and oversight of clinical
laboratories operating within their borders and some impose obligations on
out-of-state laboratories providing services to their residents. The states
in which we initially plan to engage in processing and storage activities all
currently have licensing requirements with which we believe we will need to
comply. Additionally, there may be state regulations impacting the storage
and use of blood products that would impact our business. We obtained our
biologics license from the State of California in May 2006 but there can be
no assurance that we will be able to obtain the necessary licensing required
to conduct our business in other states, or maintain licenses that we do
obtain in such states, including California. If we identify other states with
licensing requirements or if other states adopt such other requirements, or
if we plan to conduct business in a new state with such licensing
requirements, we would also have to obtain such licenses and/or comply with
such other requirements. We may also be subject to state and federal privacy
laws related to the protection of our customers' personal health information
to which we would have access through the provision of our services. We may
be required to spend substantial amounts of time and money to comply with any
regulations and licensing requirements, as well as any future legislative and
regulatory initiatives. Failure to comply with applicable regulatory
requirements or delay in compliance may result in, among other things,
injunctions, operating restrictions, and civil fines and criminal prosecution
which would have a material adverse effect on the marketing and sales of our
services and impair our ability to operate profitably or preclude our ability
to operate at all in the future.
OUR SUCCESS WILL DEPEND IN PART ON ESTABLISHING AND MAINTAINING EFFECTIVE
STRATEGIC PARTNERSHIPS AND COLLABORATIONS.
A key aspect of our business strategy is to establish strategic relationships
in order to gain access to critical supplies, to expand or complement our
development or commercialization capabilities, or to reduce the cost of
developing or commercializing services on our own. We currently have
strategic relationships with two parties. While we are in discussions with
others to establish additional relationships and collaborations, there can be
no assurance that we will enter into such relationships or that the
arrangements will be on favorable terms. Relationships with licensed
professionals such as physicians may be subject to state and federal fraud
and abuse regulations restricting the referral of business, prohibiting
certain payments to physicians, or otherwise limiting our options for
structuring a relationship. If our services become reimbursable by government
or private insurers in the future, we could be subject to additional
regulation and perhaps additional limitations on our ability to structure
relationships with physicians. Failure to comply with applicable fraud and
abuse regulations could result in civil fines and/or criminal prosecution.
Even if we do enter into these arrangements, we may not be able to maintain
these relationships or establish new ones in the future on acceptable terms.
Furthermore, these arrangements may require us to grant certain rights to
third parties, including exclusive rights or may have other terms that are
burdensome to us. If any of our partners terminate their relationship with us
or fail to perform their obligations in a timely manner, the development or
commercialization of our services may be substantially delayed. If we fail to
structure our relationships with physicians in accordance with applicable
fraud and abuse laws it could have a material adverse effect on our business.
-24-
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following securities were sold during the third quarter of 2006 in
private transactions that, unless otherwise stated, were exempt from
registration pursuant to Section 4(2) of the Securities Act and/or Regulation
D thereunder: In July and August 2006, the Company sold an aggregate of
3,977,273 shares of Common Stock to 34 accredited investors at a per share
price of $.44 resulting in gross proceeds to the Company of $1,750,000. In
August 2006, the Company issued to Duncan Capital Group LLC 17,046 shares of
Common Stock as an advisory fee payment pursuant to the terms of its advisory
agreement. In July and August 2006 the Company issued an aggregate of 83,405
shares of Common Stock in conversion of an aggregate of $40,657 in accounts
payable owed to certain vendors. The per share conversion price ranged from
$.44 to $.56. In addition, in August 2006, the Company issued 41,667 shares
of Common Stock to a service provider in payment for services rendered equal
to $25,000 at a per share price of $.60. In August 2006, the Company issued
warrants to purchase an aggregate of 170,000 shares of Common Stock at $.80
per share to four persons under advisory agreements. Such warrants are each
exercisable for five years from the date of issue. As of October 30, 2006,
investors holding $425,000 of the $500,000 of convertible promissory notes
issued in the WestPark Private Placement had agreed to convert their notes,
and accordingly, the following securities were issued: 965,907 shares of
Common Stock in conversion of the notes, an additional 107,958 shares of
Common Stock, and warrants to purchaser an additional 708,341 shares of
Common Stock at $.80 per share. Also as of October 30, 2006, investors
holding $162,500 of convertible promissory notes (of which $137,500 in
principal amount was subsequently transferred and converted by the
transferees, the securities being included in the totals above) had agreed to
extend the term of the convertible promissory notes on the terms set forth
above, and an additional 36,932 shares of Common Stock were therefore issued
to such investors.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) An annual meeting of stockholders was held on August 29, 2006.
-25-
(b) The Directors elected at the annual meeting were Robin L. Smith, Mark
Weinreb, Wayne A. Marasco and Joseph D. Zuckerman. Such persons are all of
the Directors of the Company whose term of office continued after the
annual meeting.
(c) The matters voted upon at the annual meeting and the results of the voting,
including broker non-votes where applicable, are set forth below:
(i) Election of Directors
Name In Favor Witheld
---- -------- -------
Robin L. Smith 9,682,799 23,382
Mark Weinreb 9,687,467 18,714
Wayne A. Marasco 9,681,470 24,711
Joseph D. Zuckerman 9,685,206 20,975
(ii) The stockholders approved the Amended and Restated Certificate of
Incorporation, including amendments effecting a reverse stock split of
the Company's Common Stock at a ratio of one-for-ten shares and
changing the Company's name from "Phase III Medical, Inc." to "NeoStem,
Inc." The stockholders voted 8,533,414 in favor and 1,171,435 against.
1,332 shares abstained from voting.
(iii) The stockholders approved an amendment to the Company's 2003 Equity
Participation Plan to fix the number of shares of Common Stock
authorized for issuance thereunder at 25,000,000, to provide for the
administration of the 2003 EPP by a committee of outside directors and
to provide a maximum amount of shares of 10,000,000 that may be granted
to any one person in any calendar year. The stockholders voted
7,642,260 shares in favor and 33,153 shares against. 3,425 shares
abstained from voting. There were 2,027,343 broker nonvotes.
(iv) The stockholders ratified the appointment by the Board of Holtz
Rubenstein Reminick LLP as the Company's independent certified public
accountants for the fiscal year ending December 31, 2006. The
stockholders voted 9,691,668 shares in favor and 13,066 shares against.
1,448 shares abstained from voting.
ITEM 5. OTHER INFORMATION
RESIGNATION OF BOARD MEMBER
Wayne A. Marasco, M.D., Ph.D., a member of the Company's Board of
Directors and its Senior Scientific Advisor, resigned from the
Company's Board of Directors effective as of November 12, 2006.
ITEM 6. EXHIBITS
(A) EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-26-
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.
Date: November 14, 2006
-27-
EXHIBIT 31.1
CERTIFICATION
I, Robin Smith, M.D. certify that:
-----------------
1. I have reviewed this Quarterly Report on Form 10-Q of NeoStem, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this Report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this quarterly report based on such
evaluation; and
c) presented in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has materially affected,
or is reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. I have disclosed, based on our most recent evaluation of internal control
over financial reporting to the registrant's auditors and the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 14, 2006
/s/ Robin Smith, M.D.
- -----------------------
Name: Robin Smith, M.D.
Title: Chief Executive Officer NeoStem, Inc.
A signed original of this written statement required by Section 302 has been
provided to NeoStem, Inc. and will be retained by NeoStem, Inc. and furnished to
the Securities and Exchange Commission or its staff upon request.
EXHIBIT 31.2
CERTIFICATION
I, Larry A. May, certify that:
-------------
1. I have reviewed this Quarterly Report on Form 10-Q of NeoStem, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this Report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this quarterly report based on such
evaluation; and
c) presented in this quarterly report any change in the registrant's
internal control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has materially affected,
or is reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. I have disclosed, based on our most recent evaluation of internal control
over financial reporting to the registrant's auditors and the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November14, 2006
/s/ Larry A. May
- --------------------------
Name: Larry A. May
Title: Chief Financial Officer of NeoStem, Inc.
A signed original of this written statement required by Section 302 has been
provided to NeoStem, Inc. and will be retained by NeoStem, Inc. and furnished to
the Securities and Exchange Commission or its staff upon
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of NeoStem, Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2006 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I Robin
Smith, M.D., Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition of the Company as of the dates presented
and the result of operations of the Company for the periods presented.
Dated: November 14, 2006
/s/ Robin Smith, M.D.
---------------------
Robin Smith, M.D.
Chief Executive Officer
The foregoing certification is being furnished solely pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter
63 of Title 18, United States Code) and is not being filed as part of the Form
10-Q or as a separate disclosure document.
A signed original of this written statement required by Section 906 has been
provided NeoStem, Inc. and will be retained by NeoStem, Inc. and furnished to
the Securities and Exchange Commission or its staff upon request.
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of NeoStem, Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2006 filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Larry
A. May, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition of the Company as of the dates presented
and the result of operations of the Company for the periods presented.
Dated: November 14, 2006
/s/ Larry A. May
----------------------------
Larry A. May
Chief Financial Officer
The foregoing certification is being furnished solely pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter
63 of Title 18, United States Code) and is not being filed as part of the Form
10-Q or as a separate disclosure document.
A signed original of this written statement required by Section 906 has been
provided to NeoStem, Inc. and will be retained by NeoStem, Inc. and furnished to
the Securities and Exchange Commission or its staff upon request.