August
31, 2009
Tia
Jenkins
Senior
Assistant Chief Accountant
Office of
Beverages, Apparel and Healthcare Services
Division
of Corporate Finance
United
States Securities and Exchange Commission
100 F.
Street, N.E.
Washington,
D.C. 20549
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Re:
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NeoStem,
Inc. (the "Company" or "NeoStem")
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Form
10-K for the fiscal year ended December 31, 2008
Filed
March 31, 2009
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File
No. 001-33650
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Dear Ms.
Jenkins:
We are in
receipt of your letter dated July 24, 2009 (the "Letter") regarding the review
by the Securities and Exchange Commission (the "Commission") of the Annual
Report on Form 10-K of the Company for the
year ended December 31, 2008 (the "2008 Annual Report").
As
requested, the comments and responses set forth below are keyed to the numbering
of the comments and the headings used in the Letter.
Form 10-K for the Fiscal
Year Ended December 31, 2008
Note 1 — The Company page
F-9
1. We
note that your primary business is to manage a network of adult stem cell
collection centers which are opened by medical practitioners who have signed
collection agreements. Please tell us and disclose in future filings the
significant terms of these agreements and describe the fee arrangements with
respect to how you and the medical practitioners are compensated. Tell us
whether you are responsible for any costs involved in opening and operating
these collection centers. Please discuss whether you have controlling financial
interests over these collection centers and provide us with an analysis of six
factors under EITF 97-2.
Company
Response:
1. (a)
Describe significant terms and fee arrangements of the collection center
agreements.
420 Lexington Avenue, Suite 450, New
York, NY 10170 212.584.41B main 646.514.7787 fax
The terms
of NeoStem's collection center agreements are substantially
similar. NeoStem provides adult stem cell processing and storage
services, as well as expertise and certain business, management and
administrative services of a non-clinical nature in support of each physician
practice serving as a collection center. In each case, the physician practice
agrees that NeoStem will be its exclusive provider of adult stem cell processing
and storage, management and other specified services. The agreements
also make clear that since NeoStem is not licensed to practice medicine, NeoStem
cannot and does not participate in clinical care or clinical decision making,
both of which are exclusively the responsibility of the collection center (i.e.,
the responsibility of the physician or the medical practice). The
agreements provide for the payment to NeoStem by the collection center of
specified fees for services, including marketing and administrative support
services and network services fees. In light of the
corporate practice of medicine prohibition in states in which we operate,
NeoStem is not permitted to have any equity or other ownership interest in any
of the physician medical practices that serve as collection centers. Each of the
agreements is for a multi-year period, depending on the particular center, and
typically has an automatic renewal provision for consecutive one year periods at
the end of the initial term that also permits either party to terminate prior to
renewal. The agreements may also relate to a territory from which
patients seek collection services. The agreements contain insurance
obligations and indemnification provisions, limitations on liability and other
standard provisions. NeoStem grants to each physician practice serving as a
collection center a non-exclusive license to use its trademarks and intellectual
property but otherwise retains all rights thereto, and each collection center is
bound by confidentiality obligations to NeoStem and non-competition provisions.
Generally, the agreements may be terminated by either party with prior written
notice in the event of an uncured material breach by the other party and may be
terminated by either party in the event of the other party’s bankruptcy,
insolvency, receivership or other similar circumstances.
The
Company disclosed significant contractual terms in the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2009 (in Note 1 to the
Unaudited Consolidated Financial Statements). The Company will
modify this disclosure in future filings as appropriate and will
update the information as circumstances dictate.
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(b)
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Tell
us whether you are responsible for any costs involved in opening and
operating these collection centers.
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We are
not responsible for any costs of opening or operating a collection
center.
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(c)
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Please
discuss whether you have any controlling financial interests over these
collection centers.
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(i)
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We
do not have any controlling financial interests over the collection
centers in our network. We provide services and support to physicians who
wish to offer stem cell collection services within an existing medical
practice or in stand-alone medical facilities. However, NeoStem
has no ownership interests in or financial control over these medical
practices or medical facilities.
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2
EITF
97-2, which relates to the establishment by a physician practice management
group (a "PPM") of a controlling financial interest in a physician practice,
sets out six requirements, all of which must be met in order for a company to be
deemed to have controlling financial interest over a physician
practice. Below, please find our analysis of each such requirement as
it relates to the physician medical practices that serve as collection
centers.
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1.
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The
contractual arrangement between the PPM and the practice has a term that
is either (a) the entire remaining legal life of the physician practice
entity or (b) has a period of 10 years or
more.
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i. Our
collection center agreements do not satisfy this requirement. In
general, our collection center agreements have an initial term of three to five
years in duration, although they are automatically renewable for one-year
terms. Either party may terminate the agreement for any reason upon
90 days notice in advance of the expiration of the initial term or any renewal
term or as otherwise described in 1(a) above.
ii. The
agreements do not cover the useful life or remaining life of a practice, other
than, potentially, the practice’s adult stem cell collection
operations. Adult stem cell collection operations are typically a
very small part of a physician’s overall practice. To date, the
revenue generated from the stem cell collection business has been
minimal.
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2.
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The
contractual arrangement between the PPM and the Practice is not terminable
by the Practice except in the case of gross negligence, fraud, or other
illegal acts by the PPM, or bankruptcy of the
PPM.
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Our
collection center agreements do not satisfy this requirement. As
discussed in (1)(i) above, and in 1(a) above, physician practices serving as
collection centers may terminate their agreements with the requisite advance
written notice. In addition, the agreements may be terminated by
either party in the event of an uncured material breach or the other party’s
bankruptcy, insolvency, receivership or other similar
circumstances.
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3.
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The
PPM has exclusive authority over all decision making relating to the
ongoing, major or central operations of the practice, except for the
dispensing of medical services.
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Our
collection center agreements do not satisfy this requirement. While
the physician practice serving as the collection center must follow certain
protocols under our agreements (for example restricting stem cell collections to
patients who are free of certain infectious diseases), these protocols apply
solely with respect to adult stem cell collection
operations. Otherwise, NeoStem has no decision making authority over
the larger scope of clinical services provided by the practice; patient
acceptance policies and procedures; the pricing of services; the negotiation and
execution of contracts; or the establishment and approval of operating or
capital budgets.
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4.
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In addition to 3, the PPM has
exclusive authority over all decision
making related to total practice compensation of the licensed medical professionals as well
as the ability to establish and implement guidelines for the selection,
hiring and firing of them.
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Our
collection center agreements do not satisfy this requirement. NeoStem does not
have any control over the hiring, firing, or compensation of physicians or any
licensed personnel in any practice serving as a collection center. We
do verify the credentials of any physician who wishes to provide stem cell
collection services with us, but if the physician does not pass our
credentialing process we would not establish a collection center with the
physician. In addition, while it is possible that NeoStem could choose not to
include a physician in a practice from participating in contracted stem cell
collection activities, that decision would have no bearing on the physician’s
employment status within the medical practice itself.
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5.
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The
PPM has a significant financial interest in the Practice and the Practice
is unilaterally salable or transferable by the
PPM.
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Our
collection center agreements do not satisfy this requirement. As
discussed above, NeoStem only provides support to physicians engaged in adult
stem cell collection, which is typically offered as a service within a larger
medical practice. NeoStem has no involvement in, or right to sell or
transfer any physician practice serving as a collection center.
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6.
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The
PPM has a significant financial interest in the Practice that provides the
PPM with the right to receive income, both as ongoing fees and as proceeds
from the sale of its interest in the Practice, in an amount that
fluctuates based on the performance of the operations of the Practice and
the change in the fair value
thereof.
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Our
collection center agreements do not satisfy this requirement. NeoStem
does receive (i) set fees for NeoStem’s processing and storage services; (ii)
set fees for staff training and the right to use NeoStem's know-how, protocols,
procedures, intellectual property and related items; and (iii) ongoing set fees
for administrative services, stem cell collection support and marketing
support. These fees do not fluctuate based on the overall performance
of the physician practices serving as the collection centers. NeoStem
has no rights to any proceeds from the sale of any such physician practice
serving as a collection center.
Note 2 — Summary of
Significant Accounting Policies, page F-10
Revenue Recognition, page
F-10
2. We
note that you recognize revenues related to the collection and utilization of
adult stem cells. If physicians not employed by you actually collect and utilize
the stem cells, please tell us whether you recognize this revenue on a gross
basis as a principal or on a net basis as an agent. Please refer to EITF
99-19.
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Company
Response:
The
physician practices serving as collection centers do collect stem cells, but
they do not utilize these cells for treatment purposes at the time of
collection. The stem cells are collected from healthy patients to be
banked for future use. We recognize revenues related to stem cell
collections on a gross basis as a principal.
EITF
99-19 sets out guidance for using the gross revenue reporting method of revenue
recognition as follows:
(i) The company is the primary obligor
in the arrangement.
Under our
collection center agreements, NeoStem has the primary responsibility for
determining the acceptability of the final collected stem cell
product. Acceptability is dictated by industry standards and
regulations, and our patient contracts make clear that certain aliquots of cells
may be unsuitable for storage if they fail to meet standards. If it
is determined that collected stem cells are unsuitable for storage (for example,
if it is determined that a patient failed to mobilize a sufficient quantity of
stem cells for storage) the patient is still obligated to pay the physician for
the collection services that he rendered. If NeoStem has received
payment from the patient for the totality of services (collection, processing
and storage) then NeoStem would still be obligated to remit the portion
attributable to the physician’s professional services to the
physician.
(ii) The company has general
inventory risk (before the customer order is
placed).
Even
though we are a service provider, we do have risk associated with inventory
loss. As discussed above, the patient is obligated to compensate
physicians for their professional services associated with a stem cell
collection, regardless of whether or not the stem cells prove to be acceptable
for banking and NeoStem is obligated to remit payment for the physician’s
professional services to the physician. If the cells are
damaged or destroyed, our liability is limited to the amount paid by the
client. In such case, we would either refund the fees paid by the
patient for the collection or pay for a second collection to replace the lost
cells.
(iii) The company has the latitude in
establishing prices.
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The
price of a stem cell collection is set by
NeoStem.
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(iv) The company changes the
product or performs part of the service.
Following
a physician’s collection of blood product from patients undergoing stem cell
collection and banking, NeoStem is responsible for arranging for the testing and
processing of the blood and ultimately for providing storage
services.
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(v) The company has discretion in
supplier selection.
NeoStem
has complete control over the suppliers used for stem cell processing and
banking. NeoStem is the exclusive provider of these services to
physician practices serving as collection centers, and the physician practices
must obtain prior written consent to obtain such services from other
suppliers.
(vi) The company is involved
in the determination of product or service specifications.
NeoStem
has established criteria, based on industry standards and applicable law, for
determining whether or not collected stem cells are suitable for
banking. NeoStem is solely responsible for determining whether or not
collected stem cells satisfy these criteria.
(vii) The company has physical loss
inventory risk (after customer order or during
shipping).
If cells
are lost or damaged during the transportation of those cells after collection,
NeoStem’s liability would be limited to a refund to the patient of the fees paid
or for the cost of a second collection. In such a case, NeoStem would
be obligated to pay for the professional physician fees associated with any
subsequent collection to replace lost cells.
(viii)
The company has credit
risk.
Once a
contract is signed and the collection is completed it is NeoStem's obligation to
collect the monies due from the client/patient. If NeoStem fails to collect from
the patient it is not relieved of its obligation to remit patient payments due
the physician for the stem cell collection.
3. We
note that you record revenue for start-up fees received from physicians seeking
to establish collection centers once the agreement has been signed and the
physicians have been qualified by your credentialing committee. You state that
these fees are in consideration for establishing a service territory for the
physician. Please explain why you believe that start-up fees can be immediately
recognized as revenue. Refer to Staff Accounting Bulletin Topic 13.A.3.(f) and
EITF 00-21.
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Company
Response:
Initially,
we believed that it was appropriate to recognize start-up fees immediately
because these fees were unrelated to any additional services that NeoStem might
deliver, or additional future activities in which NeoStem would need to engage.
Our purpose in charging an initial fee was to ensure the physician’s financial
motivation to promote stem cell collection services to his or her patients and
other interested individuals. Our start-up fees have ranged from $5,000 to
$30,000 per physician practice and recently have trended toward the lower
end of this range. The typical fee for collecting adult stem cells from a
patient is approximately $7,500, of which an aggregate of approximately $1,400
constitutes physician or physician practice fees for services. In a successful
physician practice providing collection services, start-up fees are quickly
recovered and do not require an extended multi-year effort for the physician to
recover such fees. Therefore, we believed that recognition of start up fees
immediately was appropriate. However, in reviewing the guidance for
revenue recognition in Staff Accounting Bulletin Topic 13.A.3.(f) and EITF
00-21, and in light of the fact that more recently, these initial fees have been
tied to certain rights and activities, we now believe that it is more
appropriate for our start up fees to be recognized ratably over the life of the
contract. During the quarter ended June 30, 2009, the Company so
modified its revenue recognition policy, which is reflected in its Quarterly
Report on Form 10-Q for the quarter ended June 30, 2009. Below is a
chart for 2008 showing the impact if we had modified our revenue recognition
policy. As demonstrated below, modifying our revenue recognition
policy would not have had a material impact on our net loss during such period
or on the overall financial position of the Company:
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Revenues
As Reported in 2008
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Start
Up Fees
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$ | 31,000.00 | ||
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Stem
Cell Collections and Storage
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51,941.00 | |||
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Shipment
of Cells
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600.00 | |||
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Other
Revenues
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- | |||
| 83,541.00 | ||||
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Revenues
as Adjusted for 2008
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Start
Up Fees
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90,050.00 | |||
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Stem
Cell Collections and Storage
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51,941.00 | |||
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Shipment
of Cells
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600.00 | |||
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Other
Revenues
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- | |||
| 142,591.00 | ||||
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Bad
Debt Expense as reported
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21,500.00 | |||
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Bad
Debt Expense as adjusted
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9,450.00 | |||
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Net
Loss as Reported
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$ | (9,242,071.00 | ) | |
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Net
Loss as Adjusted
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$ | (9,170,971.00 | ) | |
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Change
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$ | 71,100.00 | ||
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%
of Net Loss
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-0.77 | % | ||
Note 9 — Stockholders'
Equity, page F-16
(c) Warrants, page
F-24
4. In
future filings, provide a summary of warrant activity in a manner similar to
that provided for options on page F-29. Refer to paragraphs 65 and A241 of SFAS
123(R).
Company
Response:
Tables
summarizing warrant activity similar to the tables provided for stock options
were included in the Company’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2009 (in Note 6 to the Unaudited Consolidated Financial
Statements) and will be included in future filings where such disclosure is
applicable.
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Item 9A. Controls and
Procedures. page 78
(a) Disclosure controls and
Procedures, page 78
5. You
disclose "disclosure controls and procedures can only provide reasonable, not
absolute, assurance that the above objectives have been met." Please
confirm to us and revise your disclosure in future filings to clarify, if true,
that your disclosure controls and procedures are also effective in providing
reasonable assurance that information required to be disclosed in your reports
under the Securities and Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms. Refer to Section II.F.4 of SEC Release No.
33-8238.
Company
Response:
We hereby
confirm that our disclosure controls and procedures are effective, at the
reasonable assurance level, in ensuring that the information required to be
disclosed by us in the reports that we file or submit under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. The
foregoing was disclosed in Item 4 of the Company’s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2009 and will be disclosed in future
filings.
In
connection with the Company's response, we acknowledge that:
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the
Company is responsible for the adequacy and accuracy of the disclosure in
the 2008 Annual Report;
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·
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staff
comments or changes to disclosure in response to staff comments do not
foreclose the Commission from taking any action with respect to the 2008
Annual Report; and
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·
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the
Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities
laws of the United States.
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Management
trusts that the above responses will be acceptable to the
Staff. Should you have additional questions or require any further
clarification, please do not hesitate to contact me at (212) 584-4171 or at the
address set forth on the first page of this letter.
Very
truly yours,
/s/
Catherine M. Vaczy
Catherine
M. Vaczy
Vice
President and General Counsel
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