Note 13 – Discontinued Operations

Regenerative Medicine - China segment

In 2009, the Company began its Regenerative Medicine-China business in the People’s Republic of China (“China” or “PRC”) through its subsidiary, a wholly foreign owned entity (“WFOE”) and entered into contractual arrangements with certain variable interest entities (“VIEs”). Foreign companies have commonly used VIE structures to operate in the PRC, and while such structures are not uncommon, recently they have drawn greater scrutiny from the local Chinese business community in the PRC who have urged the PRC State Council to clamp down on these structures. In addition, in December 2011, China’s Ministry of Health announced its intention to more tightly regulate stem cell clinical trials and stem cell therapeutic treatments in the PRC, which has created uncertainty regarding the ultimate regulatory environment in the PRC. Accordingly, the Company took steps to restrict, and ultimately eliminate, its regenerative medicine business in the PRC. As a result of these steps, the Company has discontinued its operations in its Regenerative Medicine-China business. The Company has determined that any liability arising from the activities of the WFOE and the VIEs will likely be limited to the net assets currently held by each entity. As of March 31, 2012, the Company recognized the following loss on exit of the Regenerative Medicine-China business (in thousands):



Cash	$	195.1
Prepaid expenses and other current assets	14.9
Property, plant and equipment, net	1,023.7
Other Assets	330.5
Accounts payable	(177.1		)
Accrued liabilities	(79.2		)
Accumulated comprehensive income	(169.9		)
Loss on exit of segment	$	1,138.0

The operations and cash flows of the Regenerative Medicine - China business were eliminated from ongoing operations as a result of our exit decision, and the Company will not have continuing involvement in this business going forward. The operating results of the Regenerative Medicine – China business for the three and six months ended June 30, 2012 and 2011, which are included in discontinued operations, were as follows (in thousands):



	Three Months Ended June 30,					Six Months Ended June 30,
	2012		2011			2012			2011
Revenue	$	—	$	98.8		$	52.3		$	148.9
Cost of revenues	—		(31.3		)	(30.6		)	(49.4		)
Research and development	—		93.6			(103.3		)	(64.5		)
Selling, general, and administrative	—		(782.3		)	(497.3		)	(1,572.3		)
Other income (expense)	—		1.4			(6.8		)	(11.3		)
Loss on exit of segment	—		—			(1,138.0		)	—
Loss from discontinued operations	$	—	$	(619.8	)	$	(1,723.7	)	$	(1,548.6	)

The summary of the assets and liabilities related to Regenerative Medicine-China discontinued operations as of December 31, 2011 was as follows (in thousands):



	December 31, 2011
Assets:
Cash and cash equivalents	$	103.3
Prepaid expenses and other current assets	284.4
Property, plant and equipment, net	1,256.8
Other Assets	149.0
	$	1,793.5
Liabilities:
Accounts payable	$	177.8
Accrued liabilities	31.0
	$	208.8

Pharmaceutical Manufacturing - China segment

On June 18, 2012, the Company announced that it had entered into a definitive agreement to sell its 51% interest in Erye (the "Equity Purchase Agreement") for approximately $12.3 million in cash and the return to the Company of (i) 1,040,000 shares of the Company's Common Stock and (ii) the cancellation of 1,170,000 options and 640,000 Common Stock warrants. The closing of the transaction is subject to satisfaction of certain conditions. Closing of the transaction is expected to occur by the fourth quarter of 2012.

The operations and cash flows of the Pharmaceutical Manufacturing - China business will be eliminated from ongoing operations with the sale of the Company's 51% interest in Erye. The operating results of the Pharmaceutical Manufacturing - China business for the three and six months ended June 30, 2012 and 2011, including the estimated asset impairments based on the definitive agreement purchase price, were as follows (in thousands):



	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
Revenue	$	18,934.3		$	16,151.2		$	37,218.3		$	34,293.0
Cost of revenues	(12,214.2		)	(11,695.7		)	(25,580.0		)	(24,302.1		)
Research and development	(852.3		)	(872.7		)	(1,619.7		)	(1,102.8		)
Selling, general, and administrative	(3,160.1		)	(2,940.2		)	(6,200.1		)	(6,125.9		)
Other income (expense)	(514.8		)	(260.5		)	(1,007.4		)	(366.1		)
Provision for income taxes	(383.2		)	(213.8		)	(505.5		)	(881.5		)
Asset impairments	(27,994.6		)	—			(27,994.6		)	—
(Loss) income from discontinued operations	$	(26,184.9	)	$	168.3		$	(25,689.0	)	$	1,514.6

The summary of the assets and liabilities related to Pharmaceutical Manufacturing- China discontinued operations as of June 30, 2012 and December 31, 2011, respectively, were as follows (in thousands):



	June 30, 2012		December 31, 2011
Cash and cash equivalents	$	16,149.2	$	8,707.0
Restricted cash	1,115.3		—
Accounts receivable, net	7,317.0		5,525.7
Inventory	20,445.2		16,505.7
Deferred income taxes	350.7		463.7
Prepaid expenses and other current assets	1,461.4		777.5
Property, plant and equipment, net	36,097.2		36,490.4
Land use rights, net	4,856.2		4,872.4
Goodwill	—		8,495.7
Intangible assets, net	1,352.4		21,846.4
Other assets	2,757.8		2,459.9
Total assets	$	91,902.4	$	106,144.4

Accounts payable	$	17,310.5	$	7,950.3
Accrued liabilities	1,887.7		1,705.8
Bank loans	14,238.0		15,712.0
Notes payable	2,230.6		—
Income tax payable	1,381.5		621.6
Deferred income taxes	5,913.7		6,177.4
Unearned revenue	1,216.9		1,315.4
Amount due related parties	21,254.9		20,862.7
Total Liabilities	$	65,433.8	$	54,345.2

Concentration of Risks

For the three and six months ended June 30, 2012, three major suppliers provided approximately 31.8% and 30.0%, respectively, of Erye's purchases of raw materials with each supplier individually accounting for approximately 11.9% and 10.8%, and 10.3% and 9.8%, and 9.6% and 9.4%, respectively. As of June 30, 2012, the total accounts payable to the three major suppliers represented 28.1% of the total accounts payable balance.

Approximately 85% of Erye's revenues are derived from products that use penicillin or cephalosporin as the key active ingredient. These products are manufactured on two of the eight production lines in Erye's manufacturing facility. Any issues or incidents that might disrupt the manufacturing of products requiring penicillin or cephalosporin could have a material impact on the operating results of Erye. Any interruption or cessation in production could impact market sales.

Statutory Reserves

Pursuant to laws applicable to entities incorporated in the PRC, the PRC subsidiaries are prohibited from distributing their statutory capital and are required to appropriate from PRC GAAP profit after tax to other non-distributable reserve funds. These reserve funds include one or more of the following: (i) a general reserve, (ii) an enterprise expansion fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits (i.e., 50% of the registered capital of the relevant company), the general reserve fund requires annual appropriation at 10% of after tax profit (as determined under accounting principles generally accepted in the PRC at each year-end); the appropriation to the other funds are at the discretion of the subsidiaries.

The general reserve is used to offset extraordinary losses. Subject to approval by the relevant authorities, a company may, upon a resolution passed by the shareholders, convert the general reserve into registered capital provided that the remaining general reserve after the conversion shall be at least 25% of the registered capital of the subsidiary before the capital increase as a result of the conversion. The staff welfare and bonus reserve is used for the collective welfare of the employees of the company. The enterprise expansion reserve is for the expansion of the subsidiary’s operations and can also be converted to registered capital upon a resolution passed by the shareholders subject to approval by the relevant authorities. These reserves represent appropriations of the retained earnings determined in accordance with Chinese law, and are not distributable as cash dividends to the parent company, NeoStem. Statutory reserves are $2,479,500 and $2,488,000 as of June 30, 2012 and December 31, 2011, respectively.

Relevant PRC statutory laws and regulations permit payment of dividends by the Company’s PRC subsidiaries only out of their accumulated earnings, if any, as determined in accordance with PRC accounting standards and regulations. As a result of these PRC laws and regulations, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets either in the form of dividends, loans or advances. The restricted amount was $186,800 at June 30, 2012 and $185,000 at December 31, 2011.

Related Party Transactions

At June 30, 2012 and December 31, 2011, Erye owed EET, the 49% shareholder of Erye, approximately $21,254,900 and $20,862,700, respectively, which represents dividends paid and loaned back to Erye. June 30, 2012 and December 31, 2011 the interest rate on this loan was 6.31% and 6.56%, respectively. In June 2012 Erye paid EET approximately $374,200 of unpaid accrued interest.

Pursuant to the terms and conditions of the October 2009 Erye Joint Venture Agreement, dividend distributions to EET and the Company’s subsidiary will be made in proportion to their respective ownership interests in Erye; provided, however, that for the three-year period commencing on the first day of the first fiscal quarter after the Joint Venture Agreement became effective distributions are made as follows: for undistributed profits generated subsequent to the acquisition date: (i) the 49% of undistributed profits (after tax) of the joint venture due EET will be distributed to EET and lent back to Erye to help finance costs in connection with its construction of and relocation to a new facility (to be repaid gradually after construction is completed); and (ii) of the net profit (after tax) of the joint venture due the Company, 45% will be provided to Erye as part of the new facility construction fund and will be characterized as additional paid-in capital for the Company’s 51% interest in Erye, and 6% will be distributed to the Company. It was contemplated by the Joint Venture Agreement that the construction would continue for three years. As such, 45% of the dividend we would be entitled to by reason of our 51% ownership would remain in Erye through 2012 to complete the construction while EET would loan back their dividend during the same period at a prevailing bank interest rate. In January 2011, a dividend totaling approximately $13,671,100 based on earnings for Fiscal Year 2009 was declared and approximately $6,698,800 was distributed to EET and lent back to Erye and approximately $6,972,300 due the Company was reinvested and re-characterized as additional paid-in capital in the business. In April 2011, a dividend totaling $10,259,700 based on earnings for Fiscal Year 2010 was declared and approximately $5,027,300 was distributed to EET and lent back to Erye, and approximately $5,232,400 due the Company was reinvested and re-characterized as additional paid-in capital in the business. A10% withholding tax was required on dividends payable to the Company. As a result, Erye withheld approximately $1,220,500 in taxes related to the Company’s Fiscal Year 2009 and 2010 dividend amounts, and such amount has been paid to the local Chinese tax authorities as of December 31, 2011.

Contingencies

Chinese regulatory approvals — The Company has determined that it did not obtain all Chinese regulatory approvals (and associated registrations) required to reflect the legal title of its interest in Erye as being held by the proper entity within our group which is its current beneficial owner as that term is used under U.S. law. The Company believes that this issue will become moot through the proposed sale of the Company's equity interest in Erye to Erye's Chinese joint venture partner, EET. We have also secured Erye's agreement to obtain any necessary remedial approvals and filings in the event the Erye equity sale was not to close. As the Company has already signed a definitive agreement with EET with respect to the sale of its Erye equity interest, the Company believes that the risk of possible tax exposure and other regulatory issues in PRC associated with the foregoing filing deficiency is relatively contained.

Xiangbei Welman Pharmaceutical Co., Ltd. v. Suzhou Erye Pharmaceutical Co., Ltd. and Hunan Weichu Pharmacy Co., Ltd. involves a copyright infringement lawsuit brought in 2009 whereby Welman claimed the package inserts with respect to a particular antibiotics complex manufactured by Erye (the "Product") infringed its copyright. Erye was enjoined from copying and using the package inserts on the Product and from selling the Product with the package inserts and Welman was awarded 50,000 RMB Erye has filed application for a retrial of the previous lawsuit brought by Welman to the Hunan High Court, which application filing was accepted by the court, with the court opening date for retrial not determined yet.

In July 2011, a new copyright infringement lawsuit was brought by Welman against Erye claiming that Erye was not complying with the earlier judgment enjoining them from copying and using the package inserts for the Product. The Changsha Intermediate Court was applied to for property preservation and issued a civil decision freezing Erye's bank deposit of up to 50 million RMB, or to seal up or detain Erye's other properties of equal value. As of June 30, 2012, approximately 17.4 million RMB (approximately $2.8 million) had been frozen in six Erye bank accounts. Erye has contended that jurisdiction is not proper, and the case is now in review of the Hunan High Court.

In July 2011, another copyright infringement lawsuit was instituted by Welman against Erye in the Guangzhou Intermediate Court to (i) enjoin Erye from copying and using the package inserts from the Product and selling the drugs with the aforesaid package inserts; and (ii) award Welman economic losses of approximately 2 million RMB against Erye. The case has since been withdrawn by Welman. Welman made an application for a preliminary injunction to prohibit Erye from copying and using the package inserts from the Product and selling the drugs with the aforesaid package inserts; Welman's application was denied by the Court on September 6, 2011. Welman subsequently obtained a preliminary injunction from a lower court Guangzhou Haizhu District Court on September 14, 2011. However, on October 28, 2011, upon the appeal by Erye, the Haizhu District Court issued a decision withdrawing the preliminary injunction. Welman again applied for on April 13, 2012 and obtained on April 17, 2012 a preliminary injunction from another lower court Guangzhou Baiyun District Court. Erye has applied for court reconsideration on that granted preliminary injunction. On July 2, 2012, Guangzhou Baiyun District Court issued a decision withdrawing the injunction.