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Zacks Investment Research Senior Biotech Analyst, Jason Napodano, CFA, was interviewed by OneMedRadio where he discussed International Stem Cell Corp. See interview transcript below.

Brett Johnson: Welcome from New York, this is Brett Johnson with OneMed Radio. Today, we are with Jason Napodano who is the Managing Director and Senior Biotech Analyst at Zacks Investment Research. Zacks recently initiated coverage on International Stem Cell Corp, (ISCO) traded on the OTC. Jason, thanks for joining us today.

Jason Napodano: Thank you for having me.

BJ: So tell us about International Stem Cell, what is the firm’s business and then what’s the outlook?

JN: International Stem Cell is an interesting company from our point of view because, we’re big fans of the stem cell industry and “IS-CO”, as they like to call themselves, has a unique technology that we think could be a meaningful driver for therapeutic product development and potential licensing deals in the future. We initiated coverage with a neutral rating and a $1.50 price target and we can get into the details of the ratings if you like, but I’ll just start with their technology and a little bit of background info.

If you look at the stem cells companies out there, you essentially have two competing technologies. One that utilizes embryonic stem cells and another that utilizes adult stem cells. So real quick, embryonic stem cells are produced from a fertilized oocyte. Fertilization occurs and the cells begin to divide. You get blastocyte, cells that can be turned into embryonic stem cells and these cells are highly pluripotent, they exhibit strong proliferation, enormous potential for application and development of therapeutic products. The downside to embryonic stem cells is that you have the destruction of an embryo. You’re terminating something that could potentially develop into life, into a baby.

To get around the ethical dilemma, companies started working on adult stem cells. Adult stem cells are derived from human, it doesn’t necessarily have to be an adult human, but humans we’re talking far beyond embryos here and there are essentially two ways to get adult stem cells. You can do a liposuction procedure and get it through adipose or fat tissue, which is a rich source of stem cells far greater than bone marrow, but there are kind of questions that remain on how viable these cells are. If you look at bone marrow, well a little bit more difficult to extract. You have to do a bone marrow aspiration procedure, a little bit more complicated and you get a lower yield, but you potentially get far more viable cells than an adipose. Upside to adult stem cells is there are no ethical issues, no destruction of life. The pluripotency is lower and the proliferation is certainly far weaker than embryonic.

So along comes ISCO and they have a technology called human parthenogenic stem cells and what they do is they take an oocyte - that’s an unfertilized egg - and they activate it with their technology essentially tricking it into thinking that it’s been fertilized by a sperm. And the oocyte begins to grow and divide and instead of a zygote, which is a fertilized egg, you get a parthenagenote, which is an unfertilized egg and then it goes on to develop the blastocyte cells, but there’s zero potential that it’s going to eventually turn into a life. So you kind of get the best of both worlds with ISCO’s technology. You get the pluropotency and the proliferation of embryonic stem cells, but with no ethical issues. And I encourage your listeners to check out our research report because we’ve got an excellent diagram in there on what exactly parthenogenesis is and how these cells compare to embryonic and adult stem cells.

BJ: Has there been any sort of pushback and the same groups that were upset with the embryonic stem cells in this and is there any sort of regulatory issues the firm must  face in the development of this new technology?

JN: Yeah. I haven’t seen any. I mean again you’re basically taking an unfertilized egg and tricking it into growing and dividing so eventually that would peter out and would die. I mean there’s zero potential that you can turn this into a living organism and so I haven’t seen any ethical dilemmas or any religious objections. As far as the regulatory standpoint, well any stem cell company is going to face regulatory hurdles when they file for approval. And that kind of remains to be seen what hurdles the FDA will have to place on ISCO, but I don’t think it will be anything different from what’s out there with adult stem cells.

BJ: Where does this fit in? I mean how many stem cell companies are there now, you know, out and functioning in the US marketplace?
 

JN:     Yeah. I would say there’s at least a dozen or so maybe upwards of 15, 16 small stem cells companies. I mean there’s a basket of these guys, Geron (GERN - Analyst Report) is maybe one of the large ones, Advanced Cell Technology, Aastrom (ASTM), Cytori (CYTX - Snapshot Report), International Stem, Athersys. The interesting thing is that most of them are all small cap. In fact, if you take let’s say the 12 largest small cap stem cell companies out there and add them together, you only get a market capital of about $2B, which is about the size of some mid cap biotech stocks like Cubist Pharma or Amarin Pharma. So most of these guys are small and unproven and a basket of them runs pretty cheap.

BJ: So is that to say that sort of the stem cell place is really quite very early in this development?

JN:    Yeah, absolutely. Very few, if any, stem cell products have been approved. The FDA actually just approved an autologous stem cell therapy for fine lines and wrinkles a few weeks ago, but most companies are kind of in the early to mid stage trials. You’ve got a couple of companies that are entering late-stage trials, but as of yet, no big block busters, a whole lot of promise but not a lot of actual sales yet. I liken it to where maybe the monoclonal antibody tech companies where I would say even as far as maybe 25 years ago.

BJ: Interesting. So a lot of the applications have been in the aesthetics marketplace, is that right? And is that sort of also where International Stem Cell has got some products that they’re selling it in the skin space?

JN:      Yeah. I mean if you look at companies like Cytori, they’re certainly going after the cosmetic and reconstructive surgery market. It’s kind of a low barrier to entry market. Fibercell just got a product approved a couple of weeks ago and ISCO is generating revenues right now from a dermatology product that’s an OTC product. The rest of ISCO’s pipeline is therapeutic candidates, but they’re all very early stage.

BJ: Did you say that they’re a subsidiary, that ISCO has a subsidiary that’s in the skin space, in the dermatology space?

JN: They do, they do. If we start with their therapeutic pipeline, which is where they’re developing these human parthenogenic stem cells their therapeutic pipeline is all preclinical. The most advanced preclinical programs there are for corneal transplant, retinal pigmentation, macular degeneration. They’ve got some additional things they’re working on with liver disease, metabolic disease, neurodegenerative diseases. The corneal transplant thing is the really interesting thing. It’s a neat technology, a good opportunity outside the US, but still preclinical and hoping to enter the clinic later this year. So that could be a catalyst for the shares. And when we look at their subsidiaries, they’ve got two subsidiaries. One of them is a cell culture life science media division that sells these things to other academic labs or other pharmaceutical or biotech companies. And then they’ve got a brand new dermatology division, which is just picking up momentum and we think really could be a driver for the company later in the year.

BJ: I saw in your research report some comparative photographs I think that have been the — one you just mentioned that showed before and after skin treatment around the eyes of a patient and it seemed a pretty remarkable improvement in the reduction of wrinkles.

JN: You know, it’s really neat stuff that they did. And first and foremost, it’s an interesting story as to how ISCO entered the skincare market. As I’ve said, they sell this life science media products for growing stem cells and they sell them to other pharma and biotech companies. And the company’s chairman Ken Aldrich was at an investor meeting not too long ago and someone asked them, hey, you’ve got these media and it’s so rich for growing stem cells, why not formulate it into something that you can use on your own skin. And so, the light bulb kind of went off in the company and they took their media and cell extracts and they formulated it into a skin cream. They launched it in the first quarter. They weren’t really sure how it was going to do or what the perception was going to be and so they only made the lot of about 7000 bottles. And this is not cheap stuff, this goes for about $150 a bottle. And, lo-and-behold, all 7000 sold…never underestimate the vanity in this country, right?

BJ: Right.

JN: So all 7000 bottles sold. It generated $1.1 million in revenues and it did so well that they sold out their entire stock and they had to spend most of the second quarter rebuilding supply. So we’re not expecting much in the second quarter in terms of sales, maybe some spillover sales, but management is telling us they’ll be back on the market full swing in the Q3 and we think this is such an interesting opportunity and it’s such a large opportunity.

The cosmeceutical market in this country is a multibillion dollar market that we think they can get back up to a million in revenues in the third quarter and maybe as much $2 million in revenues in the fourth quarter. And what’s so exciting about that is it’s all non-dilutive cash coming into the company. So instead of out there issuing shares and raising money through dilutive offerings, they’re selling a product and they’re generating potentially as much as $4 to $5 million in revenues this year. I think they could do maybe as much as $8 to $10 million in revenues next year with this product that’s designed for fine lines and wrinkles in two different products, a night cream and a day cream. It’s an enormous market opportunity and we think it could be a real driver for the shares in 2012 or maybe even later this year.

And what’s exciting about ISCO is they’ve got that driver later in the year and then they’re entering the clinic hopefully later this year with human clinical testing with their corneal transplant and their retinal pigmentation therapeutic pipeline. So, we initiated with a neutral maybe a little bit of a low here as the second quarter of this summer, you know, not a lot of big numbers expected for the Q2, not a lot of updates on the pipeline. But later this year, I think you’ll hear a lot more news flow out of these guys and that’s kind of when we expect the investor interest to start coming into the story. So we initiated and we’re a little early here with our calls so we came out with a neutral. But we wanted people to get to know the name and know about these catalysts that are coming in the Q3 and Q4 and position their portfolio so that if they wanted to buy International Stem, they’re ready for 2012, which we think will be a good year for the company.

BJ:    What are the limitations of the new, the skin cream in terms of two issues. Who else is in the space and what are they selling and how does it compare to what their product, the ISCO product has been producing? And then also what are the limitations in terms of their capacity to manufacture the product?

JN: Yeah. I’ll take the second part first. They made 7000 bottles and sold them all in Q1. They’re talking about getting up to a production level where they’re going to make 10,000 bottles per month. And they think they can get there and if they get there and they’re selling there, they think they can go with limited costs to 20,000 bottles per month.

And again, this stuff sells for about $150 a bottle so do the math and you get a pretty good opportunity. As far as –

BJ: What kind of production cost? Do you have a sense on the kind of gross margins that exist for the product?

JN: Yeah. They’ve launched it kind of through a joint venture of direct marketing campaign and so they’re — with their keeping maybe about 60% of the revenues, the other 40% is kind of going to pay for the marketing, the direct campaign that they’re doing. I’m assuming kind of standard pharmaceutical type operating margins around the cogs and so maybe you’re looking at 40% net operating margin on a business like this.

BJ: Hmm… And is it marketed under a certain brand?

JN: Yes. It’s called Lifeline Skin Care. And they have something called a night rejuvenating serum, which you wear at night and then they have a day serum, which also has an SPF. So there are two products right now and they sell them either individually or together and it’s available online, and they’re looking to expand the distribution into dermatology and spas and things like that at a later date.

BJ: Interesting. In terms of competitor, I mean who else is selling something that provides a similar outcome?

JN:      Yeah. I mean everything right now is OTC and so it’s all just — I mean you’ve got some stuff that you see on the infomercials late at night stem cell therapy and skincare kind of stuff. I mean you’re talking about competing in the cosmeceutical industry for fine lines and wrinkles and so, head out to your local retail store and check out all the names the products on the aisle. You’ve got Oil of Olay and Neutroderm and, there’s an enormous number of products. I mean it’s an estimated multibillion-dollar industry.

BJ:      What’s your sense about it? From a scientific point of view, what’s behind ISCO’s product and what’s behind these other products from the science point of view? Is it comparable or they doing something unique and distinctive scientifically?

JN: No. I think they are. I think that the unique thing is that they’re looking, they’ve got these cell extracts and these media that was used to grow stem cells and grow skin culture cells. And so they’ve formulated that into something that you put on your skin to help rejuvenate and repair and grow your own cells.

So it’s not a chemical, it’s not a mask, it’s not something that you can put on to your skin and it’s just going to plump it up and then it washes off a day later. It’s certainly not as far as a surgical procedure, which is a product that FiberCell just got a surgical, but an injectible procedure. You’re not going in for a facelift of botox or anything so it’s not quite that far. But from a scientific standpoint, we think it’s beyond your typical face cream and lotion that’s just loaded with chemicals and glycols and things like that that just kind of either mask the fine lines or just kind of plump the skin up.

BJ: Interesting. Well it sounds like that could have a tremendous amount of potential and be a major driver for the company’s stock.
JN: Yeah. I mean I think right now it’s only limited by supply and marketing and word of mouth. I mean ISCO is a small company, but I think that they’re on to something here that I think at the very least could be non-dilutive capital to fund therapeutic pipeline.

It’s never going to be enough to take a billion dollar blockbuster. It still may never be enough to pay for a large phase 3 trial, but it covers their overhead and it could get them from preclinical programs into phase 1 and phase 2 programs and then their business model is very much looking to partner and looking to license their human parthogenic stem cell products. And so I think it creates a nice bridge from early stage development into that kind of mid and late stage development through non-dilutive capital and it gives them commercial experience as well. I mean they’re on the market and they’re selling the product and from an investment standpoint, it’s certainly nice to see a company that’s actually generating revenues and running a business as opposed to all just high risk clinical development.
 

BJ:      And so 2010 they did about a million and a half, is that right? In terms of top line revenues and that was all the cell culture division.

JN: That’s called Lifeline Cell Technology. The skin care is a brand new division with first sales generated in the first quarter of $1.1 million. So they’ve almost done more than they’ve all done in 2010 just with first quarter of the skin.
JN: And the way I model the skincare sales out, just kind of just based on the size of the market opportunity. And what I saw in sales in the first quarter, I think this could be a $4 or maybe a $3 or $4 million dollar opportunity this year and as much as an $8 to $10 million opportunity in the next two years.

BJ: Yeah. And it seems like if it catches on like it could, it could go much faster than — and grow much faster than that as well. I mean that would be almost conservative, wouldn’t it be?

JN:  It certainly would be. As an analyst, I don’t want to start throwing out numbers that get crazy and we’ve only been on the market for one quarter and so I’m not going to start throwing out big numbers until I see real traction. But the cosmeceutical industry is a multi-billion dollar industry. This type of facial cream and topical cream market is a multibillion-dollar market. You don’t have to get a lot of market shares to make a lot of money. And with a new product and a neat product, a niche product and the right kind of targeted marketing and effective marketing, low cost effective marketing, I think they could do pretty well.

BJ: It sounds very exciting. Thank you Jason.

JN: Thanks for having me.
 

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