LSTA

Business Context and Reporting Period

Company: NeoStem, Inc. (formerly Phase III Medical, Inc.)
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2006

NeoStem operates a commercial autologous adult stem cell bank, a business acquired via the purchase of NS California, Inc. assets on January 19, 2006. This acquisition shifted the company's principal focus from providing capital and guidance to healthcare companies to stem cell collection, processing, and storage. The company is currently in a "run-off" phase for its legacy extended warranty business, which is expected to cease generating revenue within approximately seven months. As of the reporting date, the company has not yet realized revenue from its new stem cell operations.

Key Financial Metrics

Cash Flow (Nine Months Ended Sep 30, 2006):
- Net cash used in operating activities: $(2,867,684)
- Net cash used in investing activities: $(13,073)
- Net cash provided by financing activities: $3,712,370

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased to $18,786 for the nine months ended September 30, 2006, compared to $28,201 in the prior year. This decline is attributed to the "run-off" of the legacy warranty business, with no new revenue generated from the stem cell business yet.
• Significant Increase in Expenses: Selling, general, and administrative (SG&A) expenses surged to $2,978,725 (nine months 2006) from $1,112,331 (nine months 2005). Increases were driven by payroll for new staff, legal fees, stock-based compensation ($462,908), and marketing for the new business.
• Interest Expense Spike: Interest expense increased dramatically to $1,218,122 (nine months 2006) from $71,884 (nine months 2005). This was primarily due to the early conversion of WestPark Convertible Promissory Notes, which resulted in significant non-cash interest charges related to warrant repricing and share issuances ($727,894).
• Capital Structure Changes: The company completed a 1-for-10 reverse stock split and changed its name from Phase III Medical, Inc. to NeoStem, Inc. in August 2006. All Series A Preferred Stock was converted to Common Stock.

Guidance, Outlook, and Risks

Outlook and Liquidity: Management states that the company currently has no cash-generating revenues and limited financial resources to pay current expenses. While the company raised approximately $3.57 million in 2006 through equity and debt sales, substantial additional financing is required to fully develop the business. The financial statements include a "substantial doubt" going concern warning.

Risk Factors:

• Going Concern: Auditors have expressed substantial doubt about the company's ability to continue as a going concern due to liquidity issues and a history of losses.
• Market Acceptance: Future profitability depends entirely on the market acceptance of stem cell storage services, which requires significant marketing and education of medical practitioners.
• Regulatory Compliance: The business is subject to strict FDA regulations (cGTP) and state licensing requirements (e.g., CLIA). Failure to comply could result in injunctions or fines.
• Dilution: The company has a large number of outstanding options (approx. 3.1 million) and warrants (approx. 6.2 million) that could adversely affect the stock price if exercised.

Investor Verification Checklist

• Cash Runway: Verify the current cash balance against monthly burn rates to assess immediate liquidity needs.
• Debt Conversion Status: Confirm the final status of the WestPark Convertible Promissory Notes and any remaining obligations or penalties.
• Revenue Timeline: Investigate the specific timeline for the first commercial revenue from stem cell banking, as the legacy warranty revenue is ending.
• Regulatory Licenses: Verify the status of the California biologics license and any pending applications for other states required for expansion.
• Stock-Based Compensation: Review the impact of future stock option grants and warrant issuances on shareholder dilution.