THE EASTERN PRACTICE

of preserving umbilical cords for posterity one Korean company reportedly gold-plates them for display strikes many Americans as downright odd. But a modern, life-saving variation on the centuries-old custom may soon get a boost in the U.S.

Legislation that would establish a national registry for umbilical-cord blood is now pending in the Senate. Like human embryos, blood within the umbilical cord of a newborn is full of stem cells and can be frozen and stored for therapeutic applications later in the baby's life. A national registry for umbilical-cord blood, similar to an existing one for bone marrow, would make it easier for patients in need of stem-cell therapy to find suitable donors. Stem cells have the ability to evolve into other cells, a trait that's especially beneficial in the treatment of certain blood and bone-marrow disorders like leukemia.

Several companies stand to benefit from the creation of a national cord-blood registry. Among them is Cryo-Cell International, one of the few that's publicly traded. The Oldsmar, Fla.-based company operates the nation's largest private cord-blood bank with more than 100,000 client specimens. It could grow significantly over the next few years as stem-cell technology becomes more advanced and gains more support.

The company is free of debt and expanding quickly. Its third-quarter results, reported Oct. 4, showed revenues increasing 19% to $3.8 million. The stock, which trades now at about $3 a share on the OTC Bulletin Board, was delisted from the Nasdaq Stock Market in July 2003 for failure to maintain the required $2.5 million in shareholder equity. The company hopes to regain its Nasdaq listing in 2006.

Cryo-Cell is also the first national cord-blood bank to develop a method for storing placental stem cells. Placental stem cells have the potential to treat more diseases than cord-blood cells. Although no one has developed therapeutics for the stored placental stem cells yet, Cryo-Cell believes the opportunities are vast and has an exclusive agreement on the storage technology.

SmartMoney.com recently sat down with Cryo-Cell's chairman and chief executive, Mercedes Walton, and executive vice president, Gerald Maass, to discuss the unique marketplace and the company's future.

SmartMoney.com: What are cord-blood stem cells?

Maass: Cord-blood stem cells are a form of adult stem cells that have shown themselves to be present in umbilical-cord blood in sufficient quantities to be isolated, cryo-preserved and used for transplant procedures to reverse upward of 70 relatively rare blood and bone-marrow disorders leukemias, lymphomas, immune deficiencies, that kind of thing. Increasingly, cord-blood stem cells have been used as a substitute for bone marrow in transplant procedures because they're easier to work with. They're easier to get to, there's no pain or risk associated with their collection and, in fact, they're much more pliable in transplant. One of the difficulties in bone-marrow reconstitution is that the cells have to be matched in order to be used. Cord blood, because of its immature and nonimmunogenic nature, actually lends itself better to matching other people.

That's why there's been this interest in cord blood. But that interest has always been counterbalanced with the fact that the diseases that cord blood has been used to treat, their incidence is relatively low in the population. The challenge has been: Can these stem cells be used for diseases beyond the relatively rare blood disorders? So, it's been the subject of research, and that has obviously driven interest from parents in collecting and banking the cord blood. Not only do you have [treatments for] the known diseases, but you have the potential for other kinds of diseases.

SM: How is Cryo-Cell involved?

Walton: Basically, our service is the collection, processing and cryo-preservation of umbilical-cord-blood stem cells. We are the largest private cord-blood bank in the U.S. for sure most likely in the world. We have over 100,000 clients world-wide, and we were the first established operation.

SM: How exactly does the service work?

Maass: We enroll the parents and send them a collection kit. In some cases, they can pick that up in their doctor's office or hospital. But more often than not, they're going to get their kit directly from Cryo-Cell. When they get the kit, they're ready to go. They take it to the hospital with them. Upon admission, a small amount of the mother's blood is drawn for infectious disease testing. Then, when the baby is born, the attending health-care professional does the procedure. They clamp and cut the cord and stick the needle in, and blood drains into the collection bag. They label the sample, put the mother's blood with it and hand it back to the parents. A courier is called, and they come straight to the hospital room, pick up the sample and bring it to us. There's a chain of custody from the hospital room all the way to our receiving plant.

SM: How are the cells stored and used?

Walton: The American Association of Blood Banks came out with a new standard in April of 2005 that said that processing should really be done in a closed-bag system to mitigate contamination. So, we do the actual processing totally enclosed, and then we cryo-preserve the bag. When [the specimens] are requested for transplant, they go to the institution after the appropriate quality testing. They're thawed at room temperature and placed on IV-drip, and that's how the transplant takes place. What that represents is that there's one occasion to use the cord-blood cell transplant: Once it's thawed, that's it.

SM: So, the cells do not have to be applied to an affected area?

Walton: The cells miraculously know how to go to the area of injury. They automatically go to the site of injury and repair or regenerate the damaged organs and tissue.

SM: How many clients have made a withdrawal?

Maass: Ten or 11 of our clients have actually retrieved samples and used them for transplant purposes.

SM: What are your main sources of revenue?

Walton: Our revenues come from three primary sources. There's the collection, processing and testing. We call that the initial fee. There's a recurring annual fee a storage fee that's associated with the service. The parents basically pay that fee at the anniversary of their baby's birthday. So, as our embedded base expands, so does our annuity stream of recurring revenue.

We run a very high-margin business. Our blended margins, between the annual storage service and the processing service, are in the mid-70s. So it's a very high-margin business. And we also have revenues that come in from the royalties we receive through the licensing agreements with our affiliates in Mexico and Asia.

SM: What are your main growth drivers?

Walton: The embedded base is a very key source of new business for us. About 40% of our clients are repeat customers second, third and fourth babies. Also, over 60% of our business comes from referral sources; that includes [the repeat customers], friends, families and practitioners. So the larger the base, the more potential we have for new business.

SM: Where has that left you financially?

Walton: We've had seven consecutive quarters of profitability through the third quarter of '05. We've been cash-flow positive for two years. We have a strong cash position. As of our last filing, we had about $7.2 million, $7.3 million in cash, and we have no debt.

SM: Where are your customers located?

Walton: We operate in the United States, Mexico, Canada, Central America and South America. We have affiliates also in India, who have the rights to move into Singapore and Malaysia. So we have been very strategically focused in selecting global markets where we believe the opportunity is significant. Developing countries have proved to be a very lucrative source of business for us.

SM: How many U.S. facilities are in operation now?

Walton: In the U.S., we have one facility. It's in Oldsmar, Fla.

SM: Does the mother have to give birth at a hospital near the facility?

Walton: No, the blood can be shipped. We recommend that it get to us within 48 hours of the delivery. We use special couriers.

Maass: Essentially, every cord-blood bank operates from a centralized facility using a specialized courier service.

SM: Tell us about the market for stem-cell storage.

Walton: The potential market is approximately four million births in the U.S. a year. We believe that the addressable market is about 25% of that between 800,000 and a million potential clients a year. And the market is incredibly underpenetrated. We believe the penetration is somewhere around 8.5% of the addressable market.

We think there will be a lot of industry consolidation moving forward. The service has become highly commoditized with so many players in the market. And the regulatory barriers are increasing significantly. The Food and Drug Administration took jurisdiction over private cord-blood banks in May of 2005. Prior to that time, private cord-blood banks had to register with the FDA but were not regulated by the FDA. Now, the FDA can come into any private cord-blood bank at any time, and they have the potential to effectively shut it down if it's not meeting the appropriate standards of operation.

SM: Who are the industry's major players?

Walton: We have been incorporated since 1989 and in operation since 1992. The late 90s, starting around '96, '97, is when other players started to emerge on the landscape. There are approximately 25 private cord-blood banks out there today. There are three major companies, of which Cryo-Cell is one, and we believe that the three companies represent about 80% of the marketplace.

SM: And they are...?

Walton: Cryo-Cell, Cord Blood Registry, or CBR, and Viacell.

SM: What is your competitive advantage?

Walton: We operate in a Good Manufacturing Practice/Good Tissue Practice-compliant facility, which is extraordinary. We believe we're the only cord-blood bank that is meeting the [FDA] standard at this time. We meet to the letter all of the standards that are required there. That's an important factor because the government is very interested in establishing a public cord-blood registry, and there is pending legislation that would establish $79 million of funding in part to actually establish this registry. The government has said that private competitors for this funding would have to meet the GMP/GTP standard. So, although it's not clear at this moment whether private cord-blood banks will be able to compete for this funding, if private cord-blood banks are able to compete, we believe we are in a very formidable position because we meet the standard to today.

Maass: Even though funding hasn't been established because the Senate hasn't passed their side of the bill, they're actually moving forward with a request for proposal. They have already issued a request for information. An RFP is, we think, soon to be issued on top of that.

SM: Any major research collaborations?

Walton: Cryo-Cell owns a 39% equity stake in a research and development entity called Saneron CCEL Therapeutics. It's affiliated with the University of South Florida. We effectively have exclusive rights to market any therapeutic application that they develop world-wide. Their focus is on the development of neurological applications. For example, about a year ago, they published research on laboratory experiments where they had successfully used cord-blood stem cells to reverse the effects of stroke in rats. They've also combined cord-blood stem cells with Sertoli cells to repair cardiac muscles in lab animals. We own a stake in them, but it's an equity stake, so it's not like we're funding their efforts. We don't have the cash drain, but we have the benefits of a research affiliate.

SM: What's next for the company, in terms of technology and new products?

Walton: A couple of weeks ago, we announced our Plureon product stem cells from placental tissue. Effectively, Cryo-Cell has established the exclusive rights to market this product, and we will be introducing it around March of 2006 as a bundled offering, combined with our umbilical cord service. We will be the only cord-blood bank with this kind of bundle, as far as we know. We will be the first and perhaps the only company that will offer the commercial processing and storage of placental stem cells.

Maass: [Placental stem cells are] really a very important aspect of our strategic stem-cell plan. They were discovered to be present in both amniotic fluid and placental tissue at the [Boston-based] Children's Hospital lab for tissue engineering and regenerative medicine. The technology became the subject of patent applications. Plureon Corp. was formed. It has the exclusive rights to that [intellectual property] from Children's Hospital.

Plureon and Cryo-Cell have actually entered into an exclusive agreement, whereby Cryo-Cell has the U.S. exclusive rights to develop the protocols for collection, processing, testing and cryo-preservation of these cells from placental tissue at the time of birth. On the other side of the equation, Plureon has the stated strategy of actually licensing the cell and the technology to other companies who may be interested in developing cellular therapies using the stem-cell technology. They have a significant number of stem-cell researchers looking at what the cell is capable of doing.

One of the most exciting developments is that [researchers] have actually taken the cell, injected it into mice and discovered that the cell migrates to the pancreas and forms islet cells that start secreting insulin, rendering the mouse insulin-independent. This is such a breakthrough because so many people have been working on diabetes. I mean, 6% of the population suffers from diabetes, and given this discovery, there was actually interest in securing the therapeutic development rights, to the point that some companies were actually competing. While Plureon may and probably will have several therapeutic partners, there's only one collection and banking partner, and that's Cryo-Cell.

SM: How are these cells potentially more valuable than cord-blood cells?

Maass: The cell is extremely proliferative, which has been a real challenge with cord blood, multiplying the cord-blood cells. The [placental cells] are extremely "plastic." They've differentiated into more than seven different cell lineages in the laboratory. They have gone through hundreds of passages maintaining their identity. They are not forming teratomas [tumors derived from immature cells]. The best way to describe them is that these cells have all of the advantages of embryonic stem cells without the classic disadvantages: sourcing and teratoma formation.

SM: Does the new process require FDA approval?

Maass: It doesn't require FDA approval because it's not being marketed as a therapeutic. Any therapeutic that comes from the cell technology would, but what we do is covered by FDA under the Good Tissue Practices regulations, but there's no approval, per se. It's under the FDA umbrella. We are regulated by the FDA, but our go-to-market doesn't require FDA approval.

SM: Describe your sales and marketing model.

Walton: We advertise in print ads primarily. We do a lot of Internet marketing activities. Increasingly, over the last 18 to 24 months, the practitioner has become a key influencer because the market has become so crowded that there is a much higher level of awareness about the service. Increasingly, the doctors influence the decision. We have recently announced the deployment of a dedicated sales channel that will target the clinical community. We would expect to have coverage at some point in the major metro areas, the NFL cities. Our competitors have had professional sales forces out there for some time, and we're not looking to emulate that model. We have been quite successful with our existing model. This sales deployment channel will be an enhancement.

SM: Let's talk hard numbers. What is the initial processing fee?

Walton: The initial processing fee is $1,110. That's for the collection, processing and testing of maternal blood. The annual storage fee is $115. The total first-year price is $1,225. Those are our current prices. We've announced that we anticipate a price increase effective Dec. 1. Now, the Plureon bundle, we're still in the process of finalizing the details of our go-to-market offer. What we do know is that it will be combined with the cord-blood offer. Clients will still be able to purchase the cord-blood service, but in order to purchase the placental service, they're going to have to buy the combined bundle offer. We anticipate that will be introduced to the marketplace at somewhere around $2,500 for the combined package. The annual storage fee for the placental stem cells would be comparable to the storage fee for the cord-blood stem cells. At today's prices, it would be $115 times two, so it would be $230.

SM: How does that compare with your competitors?

Maass: The two other companies that we compete with most often are priced at, respectively, $1,650 and $1,700 for their initial service fee, where we are currently charging $1,110. So, we have the ability to raise prices under the umbrella and still remain a better a value.

SM: Are customers locked into their annual rates?

Walton: Yes. When families enter a contract, they lock into that fee for the life of the service. So, for example, many of our customers are still paying $50 a year for the annual storage. That's an industry standard.

SM: How much value do the placental stem cells add to the deal?

Walton: This combined offer will really provide families with a health-care-management asset that effectively is going to grow in value over time as the therapeutic applications emerge. These cells both the cord-blood stem cells and the Plureon stem cells can be used potentially for other family members beyond the donor. So the value proposition then expands even further.

For example, in the cord-blood arena, we have a client who gave birth to a baby about six months ago, and the grandmother was diagnosed prior to the birth with leukemia. It turns out that the grandmother and the granddaughter are an exact HLA tissue match, and so the grandmother has undergone a stem-cell transplant. We're waiting for the outcome of that, but the key is that because of the primitive character of the Plureon stem cell, there is the ability of potential matching throughout a family. Effectively, you are proposing to families a potentially unlimited supply of stem cells that could be used for multiple applications for multiple family members.