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Expert Financial Analysis and Reporting

Athersys: The Coming Year Will Define Its Adult Stem Cell Product MultiStem (ATHX, $1.63)

Investment Perspective

This is my initial report on Athersys (ATHX) and its adult stem cell therapy product MultiStem. There are important data readouts upcoming on phase II trials of MultiStem in ulcerative colitis likely in 2H, 2013 and in ischemic stroke in 1Q or 2Q, 2014 that may define MultiStem's promise. Success in either trial would likely produce a dramatic, positive impact on the stock.

The company is also likely to announce a partnering deal for small molecule drug candidates in obesity and schizophrenia in 1H, 2013; these drugs have the same mechanism of action as Arena's (ARNA) Belviq, but have the promise of being more effective in reducing weight loss with potential for a better safety and tolerability profile due to superior selectivity. This is critical because safety and tolerability have a direct impact on therapeutic effectiveness (i.e. amount of weight loss). However, because these drugs are at the pre-clinical stage, I am being conservative and expecting somewhat modest upfront payment(s), but with several hundred million dollars of future milestones tied to clinical, regulatory and commercial success as well as meaningful royalties, which for a market like obesity could be substantial for a safe and effective product. An interesting aspect of this program is that the target (the 5HT2c receptor) has already been clinically validated, and potential safety issues have also been well elucidated given the history around this target (e.g. fenfluramine, dexfenfluramine, lorcaserin/Belviq). Both of these aspects could result in a more attractive risk profile (and economics) for the Athersys drug candidate and substantial value for its partner(s).

The main focus of the company is in regenerative medicine and cell therapy. Stem cell therapy has been the object of intense media and investor interest. I think that many investors intuitively sense that this could be a huge technology, but do not have a good grasp on how these therapies work, the competitive position of companies working in the space and possible timing for commercialization; I put myself in this group. I have previously written on another adult stem cell company, Neuralstem (CUR), and I am following with this report on Athersys. What I have come to believe is that stem cell companies and their technology approaches are very different. My judgment is that once you have seen one stem cell company you have seen one stem cell company.

I don't know if Athersys and Neuralstem have the best approaches to stem cell therapies, as I have not carefully analyzed most of the companies in the space and clinical trial data across the industry is limited at this early stage of development. Other companies with different approaches and products may be equally interesting. However, I am very intrigued with the technologies of both companies and each has produced interesting data in early trials.

Athersys' lead product MultiStem is an adult stem cell that has very interesting properties. The first thing that comes to mind with the mention of stem cell therapy is the transplantation of stem cells that form (i.e. differentiate into) other tissues and permanently engraft into the body. However, MultiStem does not engraft and it has other properties that make it more like small molecule drugs than products based on living cells.

As a result of the unique properties of the special cells that comprise MultiStem, material taken from the bone marrow of a single, healthy donor can be expanded to create enough product to treat hundreds of thousands or millions of patients. Furthermore, with cryopreservation, the cells can be stored for up to five years or perhaps more. Even though these cells are taken from a human donor, they do not trigger an immune response when given to an unrelated patient and do not require the concomitant use of immunosuppressive drugs. These features together make this a truly "off-the-shelf" product - one that can be conveniently stored at the hospital, and administered to the patient right when they need it. Importantly, the cells are not a permanent transplant and are ultimately cleared from the body, which also contributes to their consistent safety profile.

Based on extensive animal studies in a number of models of diverse diseases, MultiStem appears to have multiple effects which help tissue heal and/or regenerate. When MultiStem is intravenously administered, the cells home in on sites of tissue damage. They then release proteins that promote local cell growth and also aid in the creation of new blood vessels to nourish the local tissue. An additional and critical aspect of MultiStem is that it dampens the immune response at the site of injury. When tissue is damaged through disease or injury, the immune system can become overactive and excessive numbers of immune cells can aggregate at the site of damage releasing proteins that can actually compound the problem by attacking surrounding healthy cells and enlarging the area of damage.

The mode of action of MultiStem means that it can be used in a broad number of disease states in which tissue has been damaged either through disease or trauma. Promising studies in animal models have been conducted in a broad number of indications as shown below:

• Inflammatory and autoimmune disease such as inflammatory bowel disease, bone marrow transplant caused graft versus host disease, solid organ transplant and diabetes

• Cardiovascular disease such as acute myocardial infarction, congestive heart failure and PVD/PAD/CLI

• Neurological disease such as ischemic stroke, traumatic brain injury, multiple sclerosis and spinal cord injury

In all of these diseases, the common thread is that tissue is damaged and new tissue specific to the organ affected must be repaired and regenerated. In addition, a hyperactive immune response may compound the risk of damage to an organ by attacking and destroying normal surrounding tissue. The ability of MultiStem to create proteins that aid in regenerating tissue and to also down regulate the immune system may mean that it could be effective in some or all of these diseases.

The company has previously completed two phase I trials in humans that investigated the use of MultiStem; one was in recent heart attack victims and the second in patients that are at a high risk of graft versus host disease following bone marrow transplants for lymphomas and leukemias (which occurs in ~50% of these patients, and can be debilitating or lethal). The primary goal in any phase I trial is to establish safety (MultiStem has so far exhibited a good safety profile) and also to help the company gain an insight into the correct dose. Still, some encouraging signs of potential efficacy were seen in these early stage trials, and based on the results from the initial GVHD trial; the company is currently in discussions with the FDA about the possibility of moving into a phase II/III trial. It already has received FDA authorization to conduct a phase II clinical trial in the cardiovascular area when the company is ready.

Two other programs are now in advanced studies. Athersys' partner Pfizer (PFE) has launched a phase II trial in refractory ulcerative colitis that is expected to enroll 126 patients and is scheduled to report topline data later this year. Athersys is also conducting a phase II trial on its own in ischemic stroke that is expected to enroll 140 patients and is scheduled to report topline data in 1Q or 2Q, 2014. These are well powered, double blind, placebo controlled studies so that success in either trial would provide strong proof of concept for the efficacy of MultiStem.

The obvious next question investors ask is what I think are the chances for success. Unfortunately, I just can't give a confident response and I am reluctant to throw a percentage out just for the sake of doing so. On the positive side, efficacy from published studies conducted with independent labs in numerous animal models have suggested efficacy and the phase I trials in recent heart attack victims and graft versus host disease gave hints of efficacy. The multiple modes of action of MultiStem individually have been effective in treating damaged tissue and one would hope that combining these several effects in one product would produce synergy. Products often fail because of safety issues, but the extensive animal studies and more limited human studies suggest a good safety profile.

It's widely appreciated that animal studies are not always reflective of results in humans, and the phase I trials were quite small and were conducted in different disease states than the ongoing phase II trials. The traditional course of action would be to do a phase I trial in both ulcerative colitis and ischemic stroke before doing the phase II trials. However, it's interesting to note that in both of the phase II trials being run (in ulcerative colitis and stroke), smaller groups of patients were evaluated to assess dosing safety, once again with clean results seen even at very high dose levels, so once again the safety seems to be consistent.

Still, there are numerous ways that the phase II trials could produce discouraging or equivocal results even if MultiStem ultimately is shown to be effective. For example, the dose or the technique for administration of the product might be incorrect. I must also point out numerous past trials in ischemic stroke have created a vast graveyard of failed products and only one approved product, Roche/ Genentech's (RHBBY) tissue plasminogen activator Activase which is only used in about 5% of the patient population (since it must be given within 3 to 4 hours after the stroke and most patients simply don't get to the doctor in time). The point is that ulcerative colitis and especially ischemic stroke are difficult diseases to tackle. There is obvious risk with both trials, but the upside in both is substantial. Additionally success in either trial would likely create clinical development opportunities in a number of additional disease states.


Investment Opinion

Those who have followed my work are aware of the asymmetric investment strategy that I apply to emerging biotechnology companies. This is based on finding upcoming events that are not well understood and which have the potential to cause dramatic stock movements in the case of a positive outcome. In the case of Athersys, these are the phase II results in ulcerative colitis and ischemic stroke. The chances for such a positive outcome may be modest, but if it does occur the potential reward dramatically offsets the risk of being wrong. Investing in early stage biotechnology companies lends itself very much to this approach.

For an asymmetric opportunity to exist there has to be lack of awareness or extreme skepticism that a positive outcome can occur. Small biotechnology companies fit this approach because most Wall Street analyst coverage in biotechnology is focused on larger biotechnology names (symmetric investing). In addition, the large number of trial failures in small biotechnology has produced a pervasive skepticism that any clinical trial will succeed.

Asymmetric investing does not mean that an investor is smart enough to predict with certainty clinical trial outcomes. The premise is that the event has a reasonable chance of occurring, is unexpected and if it does occur the upside potential dramatically offsets the risk of losing much or all of the investment if the outcome is negative. Athersys fits the asymmetric investing strategy very well.

There are two broad potential outcomes for the critical phase II trials. The bleakest would be that the data is so discouraging in both trials that the MultiStem program is dropped. This would be devastating and leave the company in a life-threatening financial bind. These would still be some value, perhaps quite significant, in the small molecule obesity and schizophrenia program, but this may take two or three years to determine. In the short term, the stock might sell for pennies or nickels.

Promising results in the ischemic stroke trial might be the biotech event of the decade as there is an enormous unmet need and innumerable attempts to develop new drugs in this area have failed. I think the stock would experience a strong upward move driving it well into double digit price territory. Successful results in the ulcerative colitis trial would be slightly less explosive but still impressive. There are innumerable scenarios that could occur in between my euphoric and disaster scenarios. Even if results are not unequivocally positive, the stock might do quite well if clinical results suggest a path forward for future clinical trials.

Before discussing the MultiStem program of Athersys, some readers may find it useful to read a quick overview of stem cells which I have included in the appendix of this report.


Manufacturing and Expansion of MultiStem

MultiStem is an adult stem cell in the Multi-potent Adult Progenitor Cell (MAPC) family. It is manufactured from adult stem cells harvested from bone marrow or other non-embryonic tissue of human donors; it does not require subsequent genetic manipulation. The cells are taken from young, healthy, consenting donors who are usually between the ages of 20 and 25. Once isolated, MultiStem cells have very robust growth properties and can be expanded in enormous quantities through a manufacturing process developed by Athersys. A single donor can produce enough cells to treat hundreds of thousands or perhaps millions of patients. It is an off the shelf product that can be cryopreserved to provide a shelf life of up to five years, if not longer. There is a high degree of consistency of product derived from different donors, with 70 to 80% of donor derived cell product meeting the rigorous standards of the company. This scalability and consistency are critical to commercialization.


Mechanism of Action and Properties of MultiStem

MultiStem has multiple mechanisms of action that promote healing and regeneration of tissue that has been damaged by disease or injury. Pre-clinical studies indicate that after intravenous infusion, they home in on sites of injury and attach themselves, but they do not differentiate and graft into the tissue. They then express therapeutically important proteins that promote cell growth and promote formation of new blood vessels.

Another critical aspect of MultiStem is that it reduces inflammation by reducing the number of activated immune cells at the site of damage. It down regulates inflammatory cells such as activated T-cells and macrophages which reduces the expression of cytokines (proteins) which cause inflammation. At the same time, it attracts cells that are important in tissue repair and that release anti-inflammatory cytokines.

The phase I trial in patients who had recently suffered a heart attack supported findings in animal models and demonstrates how MultiStem therapy works. Intravenous administration through a catheter resulted in delivery of cells to the ischemic area and retention of cells in damaged areas of the heart. This led to the growth of new heart muscle cells and new arteries to bring more blood flow to the damaged area. By down regulating the immune response, it then prevented damage to healthy tissue surrounding the area that had been damaged by the heart attack. This mechanism of action promises effectiveness in many disease states in which tissue has been damaged.

In the treatment of stroke, preclinical studies examined both direct delivery into the brain and intravenous delivery; both approaches resulted in significant therapeutic benefits. However, intravenous delivery is clearly more practical than sticking a needle into the brains of patients, and it's significant that animal models have shown that MultiStem does not have to be delivered to the brain in order to protect or grow new neurons. While the blood brain barrier prevents most of these cells from reaching the damaged area of the brain, they appear to dampen the immune response in peripheral organs of the body, particularly the spleen. This then prevents the mobilization of T cells and B cells that would normally migrate to the brain following the initial injury, and cause significant additional damage.

An important attribute of these cells is that they are not a permanent transplant which is grafted into body tissue. They are ultimately cleared from the body like a drug which from a regulatory perspective makes it much cleaner and much simpler in terms of the development. Athersys has done extensive product characterization and is working closely with the FDA and other regulatory agencies to make sure MultiStem is a safe and well-characterized product.


Comparing MultiStem to Other Stem Cell Therapies

One way of getting a better understanding of MultiStem is to understand how it is different from other stem cell therapies. The first therapeutic application of stem cells began over 40 years ago for the treatment of leukemias and lymphomas; these are cancers of the bone marrow that affect red blood cells, platelets and immune cells that are created in the bone marrow through stem cell differentiation. In this procedure, stem cells are collected from peripheral blood or bone marrow of either healthy donors (allogeneic) or the patients themselves (autologous). The cancerous bone marrow is then destroyed by intense radiation and chemotherapy and the patient is transplanted with the donor cells which graft in the patient to form new bone marrow.

Most stem cells when isolated from the human body can't be expanded to any substantial degree as is the case for conventional bone marrow transplants. This results in a "one to one" procedure between the donor and recipient, unlike MultiStem in which one donor can provide cells that may be subsequently expanded in cell culture and banked in frozen form, providing treatment for hundreds of thousands or millions of patients. Furthermore, in traditional allogeneic bone marrow transplants, the tissue types of the donor and recipient must be carefully matched to minimize the potential for rejection. In addition, the transplant almost invariably contains a few immune cells derived from the donor that recognize the tissue of the recipient as foreign and launch an immune response (a condition referred to as Graft Versus Host Disease or GVHD). This risk occurs because in the collection of stem cells for transplant, immune cells of the donor are inadvertently collected (e.g. T cells). The result is that in about 50% of allogeneic transplants, the recipient develops GVHD. In an effort to prevent this, recipients are given immunosuppressant drugs, but frequently these drugs provide little or no benefit, or leave the patient susceptible to infection or other complications. MultiStem does not cause an immune response, nor does it require administration of an immunosuppressant drug. In fact, it is actually being developed as a way to prevent rejection for both bone marrow and solid organ transplants.

MultiStem does not do what many investors have come to expect with stem cells; they do not permanently engraft and replace damaged or injured tissue in various disease or injury models. However, they are very adept at promoting repair. They home to sites of tissue damage or injury or and then express a range of different factors that promote healing and tissue repair. Embryonic and most other adult stem cells must be "differentiated" (matured) into other more specialized cells to replace cells that that have been lost due to injury or disease. They become a permanent part of the body and administering them in their undifferentiated state also creates the risk that they might form teratomas (tumor) or ectopic tissue. MultiStem cells do not permanently engraft, do not form ectopic tissue or teratomas, and are cleared from the body within days to several weeks. In short, the cells are more like a drug than a transplant, which has obvious safety advantages.


Disease Targets for MultiStem

The modes of action of MultiStem mean that it potentially can be used in a broad number of disease states in which tissue has been damaged either through disease or trauma. Promising studies in animal models have been conducted in a broad number of indications as shown below:

• Inflammatory and autoimmune disease such as inflammatory bowel disease, graft versus host disease resulting from bone marrow transplants, rejection of solid organ transplants and diabetes.

• Cardiovascular disease such as acute myocardial infarction, congestive heart failure, PVD/PAD/CLI.

• Neurological such as ischemic stroke, traumatic brain injury, multiple sclerosis, spinal cord injury.

Athersys has conducted phase I trials in recent heart attack victims and patients suffering from graft versus host disease that support the pre-clinical findings. MultiStem is now in phase II trials in ulcerative colitis and ischemic stroke. As was just described, there are many, many other disease targets that can be approached with its mechanism of action.


Clinical Development Strategy

Over the past decade, Athersys has made its technology broadly available to expert researchers in various disease areas and allowed them to evaluate MultiStem in a broad range of potential indications. It has created an international network of collaborative relationships with leading investigators at over 30 prominent research institutions across the United States and Europe. This collaborative network has done extensive work in numerous inflammatory and immune, cardiovascular and neurological diseases. Athersys also established a partnership with Pfizer in December 2009 for the treatment of inflammatory bowel disease.

These collaborations have provided a tremendous amount of knowledge and data about how MultiStem can be relevant for treating a variety of different disease indications. Athersys has been able to cross reference data from these programs so that it could advance programs in a highly cost effective and time efficient manner. For example, in the partnership with Pfizer, it was able to obtain FDA authorization to advance MultiStem into a phase II trial in just ten months after the initiation of the partnership. This was because they could aggregate the clinical data from other programs in one package. This ability significantly increases financial and operational efficiencies.

Athersys has a portfolio-based strategy in which it has picked lead indications in several specific areas for its initial focus. In the inflammatory and immune area, a phase I study evaluated the use of MultiStem for the prevention of graft-versus-host disease. The second clinical program in this area is the partnership with Pfizer to treat inflammatory bowel disease; a phase II trial in ulcerative colitis is now underway, and a third clinical program (Phase I) has been authorized for liver transplant patients in Germany.

In the cardiovascular area, a phase I study has been completed in acute myocardial infarctions (recent heart attacks), a Phase II study has been authorized by the FDA, and the company has also completed preclinical work in other cardiovascular diseases, such as treating peripheral vascular disease and for chronic ischemia in the heart. In the neurological area, a phase II study in ischemic stroke is underway, and the company has published or presented work from animal models for other neurological injury or disease conditions, including traumatic brain injury (TBI), spinal cord injury and Multiple Sclerosis.


Third Party Validation of MultiStem

One of the critical aspects of analyzing products based on living cells is the manufacturing process which is so critical to the finished product. It is important to look for validation from third parties such as the partnering deal with Pfizer. Pfizer announced in 2008 that it was forming a business unit called Pfizer Regenerative Medicine. The idea behind this was that stem cell and cell therapy may touch many therapeutic areas in which Pfizer is interested. They recognized that they didn't have much in-house expertise in the area. After spending a couple of years looking at a broad range of technologies, announced in December 2009 that they had selected Athersys as their key partner in the area of regenerative medicine. Pfizer said "We believe this is the cornerstone of what Pfizer is going to do in the regenerative medicine area."

In November of 2012, Athersys received the BioProcess International Award for the "Technical Application of the Decade" in manufacturing for its use of an automated bioreactor system for the production of MultiStem. Other award winners included Bayer Healthcare and Technology Services and GE Healthcare. The award was based on the judgment that Athersys has demonstrated that MultiStem can be reliably manufactured in an automated bioreactor system and that the unique biological characteristics of MultiStem allow for substantial expansion of the cell product in culture, while maintaining potency and product consistency.


Phase I Study Results for MultiStem in Preventing Graft versus Host Disease or GvHD

Patients who suffer from leukemia or lymphoma are often given a bone marrow transplant as was previously described. In the case of allogeneic transplants, they are at very high risk for developing graft-versus-host disease in which the cells from the bone marrow obtained from a donor recognize the tissue in the recipient's body as foreign and launch an immune response; over 50% of allogeneic transplant recipients will develop GvHD. Athersys conducted a phase I study that evaluated the potential for MultiStem to reduce the incidence of GvHD over a period of 100 days following the transplant. The trial enrolled 36 patients; the first patients treated were given a single infusion and subsequent patients received multiple infusions.

Results from this trial were announced in February 2012. MultiStem therapy was well tolerated in both the single infusion and repeat infusion arms. There appeared to be a significant reduction in the incidence and severity of graft-versus-host disease, even following a single treatment with MultiStem. The results are consistent with previous preclinical studies that show that MultiStem provides multiple benefits in animal transplant models through reducing inflammatory damage and promoting graft acceptance.

Data highlights from the study pointed out by investigators include:

• The majority of patients participating in the study received transplants from unrelated donors (19 of 36), and nearly all of the patients received peripheral blood stem cell (PBSC) transplants (34 of 36), both of which are associated with a higher risk of GvHD;

• The relapse free survival at 100 days for patients receiving a single dose of MultiStem was 78% and for multiple doses was 83%. This compares to historical data showing about 70% for standard of care;

• All patients experienced successful neutrophil engraftment (median time of engraftment 15 days), and 86% of patients experienced successful platelet engraftment (median time of engraftment 16 days) which compares favorably to historical clinical experience for this patient group;

• Substantial reduction at the highest single dose was seen in acute GvHD incidence relative to historical experience,: 11% grade II GvHD and 0% grade III-IV GvHD);

• Evidence of a dose response relationship was seen as patients receiving the highest single dose of MultiStem had a 33% lower absolute incidence of acute GvHD relative to patients who received a single low or medium dose, and patients receiving once weekly dosing of the medium dose through the first 30 days had reduced GvHD incidence relative to single or weekly dosing over the first two weeks post-transplant;

• Limited infection-related complications were seen over the first 100 days relative to historical clinical experience, consistent with the positive effect on engraftment rates.

The study results were encouraging, and suggest that MultiStem therapy is safe and can provide clinical benefit to patients receiving allogeneic stem cell transplants. Management believes that these results could provide the basis for accelerated development and will discuss this with the FDA. The next step is a phase II or phase II/III trial. Along somewhat similar lines, a collaborating clinical center in Europe has received authorization to conduct an initial clinical trial evaluating MultiStem to prevent rejection of donated organs in patients who have received a liver transplant - these patients are typically at high risk for acute rejection.

Athersys received orphan drug designation from the U. S. Food and Drug Administration for MultiStem for the prevention of GvHD in September 2010, and also announced an issued patent around the use of MultiStem for this indication. Orphan designation is intended to facilitate drug development and provides substantial potential benefits including funding for certain clinical studies, study-design assistance, tax incentives and seven years of market exclusivity for the product upon regulatory approval.


Phase I Study Results for MultiStem in Myocardial Infarction

In November, 2011 Athersys reported data from a Phase I clinical trial in which MultiStem was administered as a single-dose, intravenous administration to treat damage from a recent heart attack. The clinical objective in a heart attack resulting from blockage of an artery in the heart often is to get the patient to the cath lab as quickly as possible in order to perform balloon angioplasty and insert one or more stents to maintain blood flow in the relevant region of the heart. MultiStem was administered concurrently in the hope that it might provide additional benefit.

A proprietary micro-infusion delivery system allowed the delivery of MultiStem directly into the relevant region of the heart quickly and efficiently in a process that takes about a minute. The trial only involved 25 patients with the primary objective being to focus on safety. However, investigators were also looking at several clinical measurements of signs of effectiveness such as ejection fraction, end-systolic volume, wall motion scores and various blood flow or stroke volume measurements over time. MultiStem showed a significant improvement in these various parameters.

The study went on to follow these patients for one year and patients continued to show improvement in key performance measurements like stroke volume and ejection fractions. Investigators judged that patients treated with a single dose of MultiStem appeared to do substantially better than the patients that received just current standard of care. The safety profile was excellent through one year and there were meaningful improvements in left ventricular ejection fraction, stroke volume and wall motion. There was also a trend toward reduced tachycardia.

Data from the study indicated that delivery of MultiStem is safe, and did not result in any clinically significant changes in vital signs, allergic reactions, or infusion-related toxicities. In addition, there were no cellular or humoral immune responses observed for up to 4 months after MultiStem injection. Following treatment, patients who exhibited significant myocardial damage and received ≥50 million cells demonstrated strong trends for improvement in both ejection fraction and left ventricular stroke volume during the follow-up period. These measures correlate with improved clinical outcomes.

This study supports previously published preclinical studies of MultiStem that showed that administration of a single dose of MultiStem can convey therapeutic benefits through multiple distinct mechanisms, such as protecting and preserving at risk tissue in the heart, reducing inflammation, and promoting revascularization through the growth of new arteries. These studies showed improvement in cardiac function and increased capillary density in the heart in both rodent and porcine models of acute myocardial infarction. This was the first human clinical study to replicate the significant improvements in heart function observed in animal models and provided an important basis for understanding the properties of MultiStem in used to treat recent heart attack victims.

Athersys reported data from this trial in 2011 but did not have the financial resources to advance MultiStem to the next stage of clinical development after its partner Angiotech was unable to continue development due to financial problems. Athersys intends to initiate a Phase II clinical trial that builds on the phase I study. This trial has been authorized by FDA and the initiation is subject to concluding a new partnership to conduct and fund the trial.


Phase II Trial of MultiStem in Ulcerative Colitis is Underway

Inflammatory bowel disease or IBD occurs in two primary forms, Crohn's disease and ulcerative colitis. These are autoimmune disease caused by an immune reaction by the body's immune system against the gastrointestinal tract resulting in inflammation in the intestines. The intestines are made up of the small intestine, large intestine (colon) and rectum that form a long tube running from the stomach to the anus. The small intestine leading from the stomach is about 20 feet long and an inch in diameter and it absorbs most of the nutrients from food and drink. It empties into the large intestine that is about 5 feet long and 3 inches in diameter which reabsorbs the water from the remaining nutrient depleted waste, creating stool. This stool is then moved along into the rectum and defecated.

With inflammatory bowel disease, the intestinal walls become swollen and inflamed, causing ulcers and sores, which can cause discomfort and digestive problems. Ulcerative colitis only involves the large intestine and rectum. Ulcers form when inflammation kills cells lining the colon resulting in pus and bleeding. When the disease is active, the main symptom is constant diarrhea mixed with blood. Ulcerative colitis is an intermittent disease, with periods of exacerbated symptoms and periods that are relatively symptom-free. Although the symptoms of ulcerative colitis can sometimes resolve on its own, the disease usually requires treatment to go into remission.

Crohn's disease has similarities to ulcerative colitis but it can affect any part of the gastrointestinal tract from mouth to anus, causing a wide variety of symptoms. When Crohn's disease attacks the small intestine, the body may not be able to absorb enough nutrients because of the chronic inflammation that results. It can sometimes make the inside of the small intestine so narrow that nothing can pass through resulting in bowel obstructions that must be treated in the hospital and sometimes requires surgery.

The relationship with Pfizer to conduct clinical trial in IBD began in December 2009 and the phase II trial in ulcerative colitis started ten months later. IBD is an area in which Pfizer has good expertise. This trial is being conducted in the US, Europe and Canada in moderate to severe ulcerative colitis. It is a double blind, placebo controlled trial that is expected to enroll 126 patients. MultiStem is administered intravenously as in the previous phase I trial in GvHD prevention and heart attack treatment. The primary efficacy measurements will be taken at 8 weeks (blinded endoscopic evaluation) and 16 weeks (clinical evaluation) and will be compared to baseline measurements (including blinded endoscopic evaluation). Safety will be evaluated through one year.

Topline results are expected in 2H, 2013. The focusing of the phase II trial on ulcerative colitis instead of Chrohn's disease is because it is easier to access the condition of the large intestine and objectively evaluate results by using an endoscope. However, any indications of success in patients with treatment resistant ulcerative colitis will probably spur subsequent clinical activity in patients with Crohn's disease.


Phase II Study in Ischemic Stroke

An ischemic stroke is a condition in which blood supply to the brain is decreased resulting in impairment in the area of the brain in which this occurs. The primary causes are: (1) a locally formed blood clot obstructing a blood vessel, (2) a blood clot traveling to the brain from some other area of the body and (3) conditions that lead to a general decrease in blood supply as might occur in shock. About 35% of strokes don't have an obvious explanation.

The rationale for this study is based on pre-clinical studies done at independent laboratories. Multiple models of neurological damage produced by strokes showed that MultiStem reduced the number of activated immune cells like T cells and macrophages and the resultant inflammatory action at the site of damage. There was also a reduction of the hyperinflammatory cascade emanating from the spleen, and the company has shown that treatment with MultiStem induces a reparative response by other cell types, including regulatory T cells (Tregs) and M2 macrophages. The overall effect was less inflammatory damage, and a neuroprotective (protecting undamaged nerves) and neurotrophic (promoting growth of nerves) activity that resulted in increased neuronal (nerve) survival in the brain, resulting in better recovery. Angiogenic and vasculogenic activity was also seen and there was enhanced repair of the blood brain barrier. A substantial and durable effect was seen even when treatment was administered seven days after the ischemic event - many animals receiving MultiStem treatment recovered virtually completely, while the control animals had significant motor skill deficits.

There is an important linkage between damage to the brain and activity of the immune system and its related immune organs like the spleen through a signaling cascade that links them. Following a stroke or traumatic brain injury, a significant inflammatory response is induced, which actually increases the amount of damage by destroying normal tissue around the damaged area. MultiStem can control and minimize the amount of damage that is done, which has led to pronounced benefits in a range of different animal models used by independent investigators.

Numerous stroke trials conducted over the last 20 years have failed. Most of these have used an approach in which the drug was administered within a few hours of the occurrence of a stroke. However, this approach presents a problem as perhaps 30% to 40% of patients will show a significant recovery within 24 to 36 hours after the stroke has occurred without therapeutic intervention. This creates a strong placebo effect which Athersys wanted to avoid in their trial. From published animal studies in which MultiStem was given days after a stroke, they saw a profound, and in many instances, virtually complete recovery. This led them to design a study in which patients are treated 24 to 36 hours post-stroke, however patients that are spontaneously recovering in the first 24 hours are excluded from the trial. This design feature eliminates a lot of the statistical noise that has been observed in previous trials.

The phase II study is a double blind placebo controlled trial that began in 2012. It is a 140 patient dose escalation trial that will be conducted at approximately 20 - 25 leading stroke centers in the US, and is focused on treating patients who suffered a stroke in the prior 1 to 2 days. In the first phase of the study, MultiStem was given in either a low dose or high dose, while other patients received placebo. In October 2012, the company announced completion of the initial portion of the study that looked at the two doses, announcing that the independent Data Safety Monitoring Board determined that each dose was safe and well tolerated and set the stage for the trial to proceed to the next level. In the remaining phase of the study, now under way, patients will receive either placebo or the high dose of MultiStem, administered in a double blind, randomized manner. The primary efficacy endpoint is based on functional improvement at three months in accordance with standard clinical performance scales and also evaluating brain structure through imaging. The primary safety endpoints are the occurrence of acute infusional toxicity, maximum tolerated dose and a composite based on dose limiting toxicities and adverse events through seven days.

There is a tremendous unmet medical need in ischemic stroke as the only approved therapy is tissue plasminogen activator or rtPA which must be given within 3 to 4 hours of the stroke. However, only about 5% of the patients who suffer a stroke get to the doctor in time to get treated with the result that 95% of the patients receive only palliative care. Based on the animal data, Athersys believes that it can administer MultiStem days after a stroke has occurred and still see profound therapeutic benefits. In the Phase II clinical trial, MultiStem will be administered one to two days after a stroke has occurred. If this trial is successful, it creates the potential for a much more clinically relevant window of treatment, possibly several days; this would be a game changer in ischemic stroke therapy. Given that more than two million patients in the U.S., Europe, and Japan suffer a stroke each year, the company estimates the market for this indication alone to be at least $15 to $20 billion annually.


Athersys' Small Molecule Program in Obesity

Athersys has a promising small molecule program in obesity. This has become a hot product development area after the approval of Arena's (ARNA) Belviq (lorcaserin) and Vivus' (VVUS) Qysmia (phentermine and topiramate); additionally Orexigen's (OREX) Contrave (bupropion and naltrexone) appears on track for approval in 2014. The well-publicized up and down struggles of these three pioneering companies to gain approval had kept many big pharmaceutical companies on the sidelines waiting for a read on the FDA's approach to obesity drugs. Now they are rushing to get into the game.

Belviq (lorcaserin) stimulates the 5HT2c receptor in the brain, an effect that suppresses appetite. The prototype drug of this type was fenfluramine which
in combination with an amphetamine-like drug called phentermine was launched by Wyeth in the mid-1990s. Popularly known as "fen-phen" this drug was initially very successful. However, fenfluramine is relatively non-selective and also stimulates 5HT2b receptors in the pulmonary artery. This can cause narrowing of the pulmonary artery leading to pulmonary hypertension and potentially failure of the pulmonary valve. This unexpected and catastrophic side effect led to the withdrawal of fen-phen and a flood of law suits. Arena's lorcaserin is a much more selective agonist of 5HT2c that results in it having efficacy without the disastrous side effects of fenfluramine. However, an interesting limitation of Lorcaserin is that it is not very selective against 5HT2a, which can result in dizziness, nausea and headaches. This limits the amount of drug patients can take and results in only modest weight loss as a result.

With the approval of lorcaserin, drugs that affect the 5HT2c receptor have become very interesting potential drug candidates for big pharma. Interestingly, in the aftermath of the fen-phen disaster, most major pharma companies abandoned their programs in the area. However, Athersys has had a program in this area for over a decade, believing that it could develop compounds that are both potent and highly selective, and as a result safe and effective. In fact, the company entered a compound into clinical development in 2008, but issues with toxicity in rodents resulted in further development being halted. Subsequently, it has used the experience gained to develop better compounds with better selectivity that promise enhanced efficacy and safety.

Management now believes that it has unlocked the key structural elements to achieve an unprecedented degree of selectivity and has shown evidence that multiple compounds (from chemically unrelated families) that it has in preclinical development are much more selective to the 5HT2c receptor than lorcaserin and have virtually no effect on either 5HT2a or 5HT2b. The 5HT2a receptor is associated with central nervous system effects (it is the receptor for LSD) and 5HT2b as previously described is associated with pulmonary artery hypertension.

Management believes that there is an opportunity to improve substantially on Belviq/lorcaserin's modest ability to reduce weight without the cost of more side effects. The lack of 5HT2a activity in the Athersys compounds allows for higher and more efficacious doses and the lack of 5HT2b activity gives an improved profile for long term use. The result is expected to be a significantly better therapeutic index than lorcaserin as has been seen in preclinical studies. Importantly, Athersys has developed compounds that do not induce receptor internalization or desensitization, which means these compounds should result in longer -duration of activity. Finally the company has developed compounds that display a half-life that is consistent with once a day dosing (another potential advantage over Belviq, which is administered twice per day).

The company has stated that one of its highly selective 5HT2c inhibitors is about a year away from the clinic. In preclinical models, the efficacy is comparable to Qsymia and superior to Belviq. Combinations with phentermine or phentermine plus topiramate both show superior efficacy to Qsymia. The development strategy is to partner this program and numerous partnering talks are ongoing. However, obesity is just part of the discussion as there is also interest in this compound in the treatment of schizophrenia. Pfizer recently showed proof of concept that targeting the 5HT2c receptor may be effective in treating schizophrenia; this was shown in a phase II proof of concept trial with a compound called vabicaserin. An effective schizophrenia drug that also reduces weight (or does not cause weight gain) would have a very significant differentiation in the market place. The currently used typical and atypical schizophrenia drugs all cause troublesome weight gain.

Athersys is expecting to announce a partnership in 1H, 2013. Management has not discussed the companies with whom it is talking, but I would expect that it would be one of the big pharma companies that has an interest in and the capacity to sell schizophrenia and obesity drugs. Eli Lilly (LLY) and Astra-Zeneca (AZN) come to mind. Successful development of this type of compound for obesity and schizophrenia would have huge commercial potential, but the Athersys drug candidates are still in a high risk pre-clinical stage. However, given the size of the schizophrenia market (currently $18 billion annually) and the potential of a multi-billion dollar obesity market, I would look for a respectable upfront payment in any partnering deal, with substantial additional milestones tied to clinical, regulatory and commercial success, along with healthy royalties.



Athersys has never been in the position of having huge amounts of cash to aggressively move its pipeline forward. Over the seven quarters ending with 3Q, 2012, it usually showed $10 to $25 million of cash on its balance sheet and an operating cash burn rate of $4 to $5 million per quarter. Management has been skillful in using in using its network of clinical researchers to create valuable pre-clinical data for MultiStem in various disease models, and it has had enough cash to perform the phase I trials in myocardial infarction and graft versus host disease.

The major cash need for the upcoming year will be for the conduct of the phase II trial of MultiStem in ischemic stroke as Pfizer will be footing the bill for the phase II ulcerative colitis trial. I am estimating that the prospective burn rate will be about $5 million per quarter. During 4Q, 2012 the company raised $21 million in a public offering which could bring 2012 year end cash in at about $25 million or higher. This is enough cash to see the company through the phase II trial results for ulcerative colitis in 2H, 2013 and probably phase II data in ischemic stroke in 1H, 2014. If the company is able to obtain capital through a partnering deal for its obesity and schizophrenia drug candidates, and/or additional partnerships in the regenerative area, it would not only off-load development costs, it would further solidify the balance sheet, and enable it to pursue additional opportunities.





Stem Cell Overview

The most common cells in the human body are 200 types of specialized cells which make up the internal organs, skin, bones, blood, and connective tissue. Stem cells have unique properties that distinguish them from specialized cells: (1) they do not perform any direct function in the body as do specialized cells, (2) they can turn into specialized cells in a process called differentiation and (3) they can divide and create duplicates of themselves, sometimes after they have been dormant for long periods. Specialized cells can only replicate into identical specialized cells.

Stem cells do not perform specialized functions such as heart cells which work in conjunction with neighboring heart cells to pump blood. However, they can change into specialized cells like heart cells. The therapeutic goal in most stem cell technologies is to graft the appropriate type of stem cells into damaged organs that can then differentiate into specialized cells and treat disease and injuries that have been difficult or impossible to treat effectively with current drugs.

At a casual first glance, stem cell therapy could appear to be straightforward. Why not just find the appropriate stem cell, deliver it to the area such as the heart where you want to grow new cells and let things happen? It is infinitely more complex than this. Stem cells are not so easy to isolate and expand. Moreover their action in the body is not well understood as they interact with surrounding cells in extremely complex ways. Product development efforts using the same starting material can produce very different products.

Stem cell therapy holds the promise of being a major step forward or even a paradigm shift in treating human disease. In my opinion, this is inevitable, but the question is how long will it take and will the small companies now pioneering the technology be winners or historical footnotes? The history with monoclonal antibodies is illustrative. The key discoveries for producing monoclonal antibodies occurred in the early 1970s and the Nobel Prize for their discovery was awarded in 1984. However, it took until 1997 to launch the first major product based on monoclonal antibodies, Rituxan (rituximab), (which has current sales of $6+ billion). Stem cell therapy may also take a long time as the first products are just beginning to be studied in humans, but it could be one of the next great drivers of biotechnology.


Embryonic and Adult Stem Cells

There are numerous types of stem cells but they are broadly classified into two categories: embryonic and an "all other" category called adult stem cells. Embryonic stem cells can ultimately differentiate into all of the cells that make up the body such as the heart, lung, skin, sperm, eggs and other tissues. They are obtained from human embryos created through in vitro fertilization procedures, not from eggs fertilized in a woman's body. Unwanted embryos that would otherwise be destroyed are obtained with the informed consent of the mother. Because these embryos have the potential for life, they are the focus of ethical issues on stem cell research.

Adult stem cells are found residing in tissue such as bone marrow, muscle, and brain and typically generate the cell types of the tissue in which they reside. While embryonic cells can potentially lead to the creation of any cell in the body, adult stem cells generally give rise to specific populations of specialized cells. They can generate replacements for cells that are lost through normal wear and tear, injury or disease. For example, hematopoietic stem cells create red and white blood cells and neural stem cells can create neurons, astrocytes and oligodendrocytes that make up the central nervous system.


Manufacturing Stem Cells

The manufacturing process for stem cells is significantly different from small molecule drugs that are made through chemical processes. They bear more similarity to monoclonal antibodies and recombinant DNA produced products in which living cells produce drugs which are then harvested. However, the growth, expansion and preservation of living stem cells produce new and major challenges. The cells are grown in cultures and the living cells produced are the product. The challenge in manufacturing is to reproduce stem cells without allowing them to change into specialized cells. For example, embryonic stem cells tend to clump into embryoid bodies and spontaneously differentiate into various specialized cells when grown in culture.

Adult stem cells primarily form the specialized cell types of the tissue in which they reside. They can divide when needed and can give rise to mature cell types that have the characteristic shapes, specialized structures and functions of that particular tissue. Specific types of adult stem cells and the specialized cells into which they develop are as follows:

Hematopoietic stem cells in bone marrow give rise to red blood cells, B lymphocytes, T lymphocytes, natural killer cells, neutrophils, basophils, eosinophils, monocytes, and macrophages.

Mesenchymal stem cells in bone marrow give rise to bone cells (osteocytes), cartilage cells (chondrocytes), fat cells (adipocytes), and other kinds of connective tissue cells such as those in tendons.

Neural stem cells in the brain and spinal cord give rise to neurons, astrocytes and oligodendrocytes. Neuralstem's technology is based on neural stem cells.

Epithelial stem cells in the lining of the digestive tract give rise to absorptive cells, goblet cells, paneth cells, and enteroendocrine cells.

Skin stem cells in the epidermis and at the base of hair follicles give rise to keratinocytes, which migrate to the surface of the skin and form a protective layer, epidermis and hair follicles.

Transdifferentiation Certain adult stem cell types can differentiate into cell types seen in organs or tissues other than those expected. For example, neural stem cells in some situations can differentiate into blood cells.

Typically, there is a very small number of stem cells in each tissue, and once removed from the body, their capacity to divide is limited, making generation of large quantities of stem cells difficult. They can generate a line of genetically identical cells that also have the ability to differentiate into all the appropriate specialized cell types of the tissue. The basic role of adult stem cells in creating and repairing tissue gives hope that they can be used to treat innumerable diseases and injuries. This is the therapeutic goal of Athersys' technology base that has given rise to MultiStem.

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