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CTSO: Germany Reimbursement Rebounds, Drives Strong Record Product

11/21/2017

By Brian Marckx, CFA
 
NASDAQ:CTSO

Q3 Financials / Operating Update: Germany Reimbursement Rebounds, Drives Strong Record Product Sales… 

CytoSorbents (NASDAQ:CTSO) reported financial results for their third quarter ending September 30th and provided a business update.  Product sales returned to growth – on both a yoy and sequential basis and set a new record high, eclipsing the previous best (Q2 2017) by 13% and beating our estimate by a healthy 10%.  The recent inflection in product sales is encouraging given that they edged down from Q4 ’16 to Q1 ’17 – which was attributed to a change in reimbursement in Germany.  At that time, management indicated that they expected the issue would dissipate with availability of the new (i.e. higher) payment rates in that country.  

Indications, including results of a survey (about reimbursement) of some of CTSO's key German accounts as well as an increase in rates by as much as 100% in some locations, suggest that is what has happened.  Certainly, the sequential revenue growth also supports that same theme - product revenue grew 17% from Q1 to Q2 and another 13% from Q2 to Q3.

While we think the potential for qoq volatility in product sales remains, we also continue to believe product sales will trend higher given several catalysts which we have discussed in prior updates.  These include the improved reimbursement picture in Germany, continued robust product sales growth from existing distributors OG (i.e. outside of Germany), recently established distribution in new territories and initial roll-out of the Fresenius co-marketing agreement.  Additionally, new product launches, such as the recently-introduced ECMO kit could provide incremental upside.  And, with ~60 investigator initiated studies either ongoing or planned as well as potential near-term publication of the REFRESH I data, there should be a regular flow of additional clinical and outcomes data to help further enhance the marketing message.       

Financials…

Total revenue was $3.8M, up 59% yoy, up 7% sequentially and 4% higher than our $3.7M estimate.  Product revenue came in at $3.5M, up 61% yoy and 13% sequentially.  Grant income was $376k.

While most of the revenue-related focus is and should be on product sales, we think it’s relevant to point to a trend related to grants.  Not only has grant income been robust as of late, it continues to trend higher.  Through the first nine months of 2017 CTSO recorded $1.4M in grant-related revenue – which is more than any prior full-year period.  Perhaps, even more significant is that the company currently has ongoing contracts with more than $2.7M of funding remaining.  Beyond subsidizing R&D, we think the fact that the list of contracts from U.S. government agencies continues to grow provides additional validation of the potential of CTSO’s technology.  These also may presumably result in new technology that could provide some optionality in terms of commercial programs that CTSO could pursue.    

The last three most recent grant awards are funded by the United States Army Medical Research Acquisition Activity (USAMRAA), including two in May and one in September.  This includes funding of up to $999k over two years for a phase II contract related to the development of HemoDefend in enabling universal plasma.  The other one awarded in May is a phase I contract which will pay up to $719k over four years and relates to novel hemoadsorptive therapies for severe burn injuries.  Then in September a phase II SBIR contract worth up to $1M was awarded – this relates to the development of potassium binding sorbents to be used in the treatment of traumatic injury and acute kidney injury – this contract follows the related phase I grant that CTSO scored in July 2016.    

Relative to product sales, much of the growth has been attributed to improved reimbursement in Germany.  And while Germany has been a significant contributor to revenue, that market may still remain relatively untapped given their significant population and large hospital network.  Management has indicated that adoption in that country has been brisk and aided by strong support by certain KOLs. One hospital in Germany already generates over $1M in product sales for CTSO.  With over 400 mid-to-large hospitals in the country, we think there is considerable near-term upside from that market. 

As we explained in our Q1 update, we felt that since we viewed Germany as CTSO's most important territory relative to both near-term sales as well as opportunity for growth, that it was important that any reimbursement-related headwind be rectified so as to not create a long-term hangover.  Management's comments on both the Q2 and Q3 calls indicating that reimbursement in that country has significantly increased from earlier in 2017, and may further broaden throughout additional hospitals, and coupled with the strong sequential product revenue growth, is highly encouraging in that regard. 

Product margin, at 69%, was also a highlight.  In fact, we looked back through our historical models and it appears that this is the highest in recent history and second highest of all time (Q3 2013 hit 71%).  Management again cited the mix of direct versus distributor sales as the main influence to product margin.  This compares to 65% in Q2 2017 and 68% in Q3 2016.  With a new manufacturing facility slated to come online in early 2018, management expects efficiencies to result in further improvement in product margin – they are guiding for gross margin to grow to 70% or better in 2018 and have additional future upside from there.  

Operating expenses were $4.5M, roughly flat from Q2 although up about $1M from the prior-year comparable period.  Similar to Q2 of this year, the increase from the prior year period relates almost entirely to higher (non-cash) stock compensation.  Excluding the increase in stock comp, operating expenses were actually about $500k lower than our estimate.

While R&D expenses, which have averaged ~$500k per quarter through the first three quarters of 2017, remains relatively low (as a result of the conclusion of REFRESH I), we expect these expenses to climb with commencement of REFRESH II (which could potentially happen prior to current year-end).  As it relates to SG&A – we continue to model this line to grow at a lower than historical rate as compared to revenue given leverage of certain fixed costs which should also help to improve profitability. 

Cash used in operating activities was $2.2M and $6.1M ($1.4M and $4.5M, ex-changes in working capital) in the three and nine months ending 9/30/2017, respectively.  Cash balance, recently bolstered by $1.5M raise from the sale of common equity (via ATM), was $15.4M at quarter-end.  Subsequently, another $1.1M was raised via the ATM.  CTSO expects current cash balance to fund operations into 2019.  

We are maintaining our $12/share price target. See below for free access to our most recent report on CTSO.


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