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Research Report Update

Progress on Product Sales, Gov't Contracts, Commercialization Plan

11/27/2012

By Brian Marckx, CFA

Q3 Results  /  Ph II U.S. Army Grant

CytoSorbents (OTC BB:CTSO) reported results for the third quarter ending September 30, 2012.  Aside from recognizing a greater amount of grant income than we estimated, results remained very much in-line with our numbers.  And importantly, the operational plan including the status of the commercial introduction in Europe as well as progress with work related to the government contracts remains largely on-track with expectations.  As a result, we have made no material changes to our model or outlook for CytoSorbents following Q3 results and are maintaining our Outperform rating and $0.50/share price target. 

Q3 revenue came in at $605k, well ahead of our $196k estimate, and included $592k in grant revenue which is mostly related to the first milestone from the DARPA contract (we modeled $100k in grant revenue).  As a reminder, in early August CTSO announced that they were awarded a milestone-based contract from DARPA worth up to $3.8 million over the next five years, including $1.5 million expected during year 1.  CTSO should also soon begin recognizing revenue from the phase II U.S. Army grant (see below).

Operating expenses were $1.06 million compared to our $1.30 million estimate - some of the difference is attributable to a reclassification of grant-related cost of goods (which we had been modeling to run through operating expenses but are now being accounted as COGS).  And even despite difference in accounting, gross margin still came in well ahead of our estimate (77% A vs. 63% E).  The net result of the beat on revenue, gross margin and operating expenses was net income and EPS of $(1.3) million and $(0.01) compared to our $(2.0) million and $(0.01) estimates.

Cash

Cash used in operations was $636k, down significantly from the $1.07 million and $1.15 million used in Q1 and Q2, respectively.  CTSO exited Q3 with $2.06 million in cash and equivalents, up from $1.74 million at the end of Q2.  During Q3 CTSO raised $950k from the sale of about 7.6 million shares under the LPC stock purchase agreement. 

Operational Update

As noted, the operational status remains in-line with earlier expectations and progress continues to be made with the commercial introduction of CytoSorb, which was initiated during the Summer.  In the last few months CTSO brought on a VP of Sales and Marketing, added three additional key sales people and completed training of their sales team.  The sales team immediately began calling on their established network of contacts.  These efforts have started to turn into revenue - while product sales were only $14k in Q3, CTSO noted in the earnings release that they've already booked ~$70k in product sales in Q4 (as of the 11/21/2012 earnings release date).  CTSO is also looking to potentially supplement its in-house sales team with third-party distribution.    

CTSO indicated that CytoSorb has already been introduced to key opinion leaders throughout Germany, Austria and Switzerland - some of which are already using the device or interested in beginning to do so.  We view this as a meaningful step towards potential (eventual) full adoption of CytoSorb in the critical care units of the various hospitals which have shown interest in the device.  CTSO also continues to supplement their direct sales efforts with awareness-building via investigator initiated human studies and noted in the Q3 earnings release that six such studies are in the planning or discussion stage for a number of critical care applications.  CTSO also remains very active in presenting at industry conferences.

Relative to the government contracts, as we've noted in the past, these not only afford a source of interim funding to help further CTSO's commercialization efforts, they also potentially broaden the menu of applications (into areas such as burns, trauma and smoke inhalation) for the device and provide greater visibility and credibility of CytoSorb and the underlying technology.            

CTSO Awarded Ph II U.S. Army Grant (from our September 24, 2012 Investor Note)

This morning (9/24/2012) CytoSorbents (CTSO) announced that they were awarded the Phase II Small Business Innovation Research grant from the U.S. Army which the company had previously submitted for.

As a reminder, in December 2011, the U.S. Army Medical Research and Materiel Command awarded CytoSorbents a Phase I Small Business Innovation Research (SBIR) grant entitled “Investigation of CytoSorb cytokine and myoglobin removal in the treatment of trauma” valued at $100,000 over six months.  Following completion of the Phase I portion (i.e. - planning phase), CTSO submitted for the Phase II grant.  The Phase II portion is worth up to $1M and will include animal studies.  A Phase III grant could follow which would entail human studies.  This program is intended to yield animal and human data that can be used to treat trauma and burn patients in the future.  This directly addresses the major reasons why warfighters dies - sepsis and infection, polytrauma, and burn injury - which could potentially open the door to other military funding programs if successful. 

Similar to the DARPA awards, we view the Phase II SBIR grant significant not only from a near-term revenue and cash flow perspective (Ph II will pay up to $1MM over one year which we had already incorporated into our model), but potentially more importantly it provides CytoSorbents and their technology with greater awareness, expanded applications beyond sepsis and trauma (into burn and smoke injury), and further credible validation (U.S. Army has clearly taken notice and CTSO notes that the U.S. Air Force also has expressed interest in their technology).

In addition, the animal data from these grants and awards, assuming positive, can be used to support CTSO's clinical efforts in Europe and facilitate the commercialization overseas for trauma, burn and smoke injury.  Following completion of the Phase II portion, human data from a potential Phase III award if granted, could potentially facilitate the company's U.S. program and help accelerate eventual U.S. approval and commercialization for non-sepsis related applications. 

 To access a free copy of the most recent CTSO research report, please CLICK HERE.