Business Context and Reporting Period
Company: NeoStem, Inc. (formerly Lisata Therapeutics, Inc.)
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2010
Business Overview: NeoStem operates as a multi-dimensional international biopharmaceutical company with three distinct business units: (i) U.S. adult stem cell collection and storage, (ii) China adult stem cell initiatives, and (iii) China pharmaceuticals via a 51% controlling interest in Suzhou Erye Pharmaceuticals Company Ltd. ("Erye"), acquired in October 2009. Erye is a vertically-integrated manufacturer of generic antibiotics.
Key Financial Metrics
| Metric | Q1 2010 | Q1 2009 |
|---|---|---|
| Total Revenues | $15,833,178 | $45,138 |
| Gross Profit | $4,981,560 | $19,621 |
| Operating Loss | $(2,608,296) | $(1,856,948) |
| Net Loss (Consolidated) | $(3,283,832) | $(1,867,243) |
| Net Loss Attributable to Common Shareholders | $(4,712,183) | $(1,867,243) |
| Loss Per Share (Basic & Diluted) | $(0.12) | $(0.24) |
| Cash and Cash Equivalents (End of Period) | $11,418,201 | $392,791 |
| Working Capital | $10,659,104 | N/A |
| Total Debt (Notes Payable & Bank Loans) | $14,782,356 | N/A |
Note: Q1 2009 figures do not include Erye operations as the acquisition occurred in late 2009.
Material Changes vs. Prior Period
- Revenue Surge: Revenues increased from $45,138 in Q1 2009 to $15.8 million in Q1 2010. This is almost entirely attributable to the inclusion of Erye's pharmaceutical sales ($15.77 million), whereas prior year revenue was derived solely from stem cell services.
- Expense Growth: Operating expenses increased by 304% to $7.59 million. This includes significant increases in Selling, General, and Administrative (SG&A) expenses ($6.29 million vs. $1.62 million) and R&D expenses ($1.30 million vs. $0.25 million), driven by the consolidation of Erye, expansion of China operations, and increased share-based compensation ($2.06 million).
- Inventory Build-up: Inventories increased by $4.6 million to $17.6 million, primarily due to the acquisition of Erye's pharmaceutical inventory and raw materials.
- Capital Structure: The company raised approximately $6.8 million in net proceeds from a public offering of common stock in February 2010 and $1.75 million from the exercise of warrants by RimAsia Capital Partners in March 2010.
Guidance, Outlook, and Risks
- Capital Requirements: Management expects to incur additional operating losses and negative cash flow in the near term. The company anticipates needing substantial additional capital to fund R&D, the construction of a new Erye manufacturing facility (estimated total cost $30 million, with $20 million paid as of March 31, 2010), and China expansion.
- Dividend Restrictions: Under the Joint Venture Agreement with Erye's minority shareholder (EET), only 6% of Erye's net profit is distributed directly to NeoStem for operating expenses. The remaining 94% is reinvested into Erye's new facility construction or loaned back to Erye.
- Internal Control Weaknesses: The company disclosed that its disclosure controls and procedures were not effective due to material weaknesses inherited from the CBH acquisition. These include insufficient U.S. GAAP qualified personnel at the China subsidiary, a lack of an internal audit system, and ineffective financial statement closing processes. Remediation is ongoing.
- Liquidity Risk: While cash balances improved to $11.4 million, the company warns that trading volume and history of losses may make raising capital difficult. Currency conversion regulations in China may also limit the ability to channel funds to Variable Interest Entities (VIEs).
Investor Verification Checklist
- Internal Control Remediation: Verify the progress of remediation plans for the material weaknesses in internal controls over financial reporting, specifically regarding the China subsidiary (Erye).
- Capital Expenditure Funding: Confirm the funding sources for the remaining $10 million required to complete Erye's new manufacturing facility, given the restricted dividend distribution policy.
- Related Party Transactions: Review the terms of the loan from EET (minority shareholder) to Erye ($7.7 million) and the associated interest payments, as well as the lock-up agreements with major shareholders like RimAsia.
- Share-Based Compensation: Assess the impact of the $2.06 million in non-cash share-based compensation expenses on future cash burn and dilution, noting the significant number of outstanding warrants and options.
- Regulatory Compliance: Monitor the status of regulatory approvals for stem cell therapies in China and the U.S., as well as the cGMP certification for Erye's new facility.