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CTSO: Product Revenue Sets New Record, Further Growth Expected in 2H

By Brian Marckx, CFA


Q2 Financials / Operating Update: Product Revenue Sets New Record, Further Growth Expected in 2H

CytoSorbents (NASDAQ:CTSO) reported financial results for their second quarter ending June 30th and provided a business update.  Product sales rebounded strongly from the slight (i.e. < 1%) sequential decrease from Q4 to Q1, jumping 17% sequentially and 64% on a yoy basis to just over $3M in Q2.  Much of the re-acceleration in product sales growth appears to be related to firming up of reimbursement in Germany.  

As a reminder, a dedicated reimbursement code recently became available in Germany but with some hospitals delaying purchasing as they awaited notification regarding payment rates, Q1 product sales were negatively impacted.  But, based on a survey (about reimbursement) of some of CTSO's key German accounts as well as the 21% sequential growth in product sales related to that country from Q1 to Q2, that headwind appears to have begun to reverse.  

With some hospitals still yet to renegotiate payment rates under the new dedicated code but which could do so throughout the remainder of the year, we think it is likely that additional related benefit shows up in 2H 2017.  With Germany accounting for approximately 60% of total product sales, any additional acceleration from that territory could have an outsized positive impact on total revenue.  Attractive reimbursement could also facilitate increased utilization from existing customers as well as initial adoption of prospective accounts.  Similar reimbursement in other European countries, if eventually established, presents another potential catalyst. 

Management continues to guide for product sales to increase sequentially from 1H to 2H.  While not providing specifics relative to the expected catalysts, we think 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 could all be meaningful contributors.  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.      

Total revenue was $3.6M, up 61% yoy, up 18% sequentially and 12% higher than our $3.2M estimate.  Product revenue came in at $3.0M, up 64% yoy and up 17% sequentially.  Grant income was $525k - which is the highest of any quarter since Q4 2013 (i.e. when the DARPA grant was highly active).  

Grant income benefitted in-part from two new awards which both came in May and are funded by the United States Army Medical Research Acquisition Activity (USAMRAA).  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, a phase I contract which will pay up to $719k over four years, relates to novel hemoadsorptive therapies for severe burn injuries.  The addition of these two grants has incrementally increased our total modeled through 2021.   

As noted, much of the strength in product sales was 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 the Q2 call indicating reimbursement there has already significantly increased (and may further broaden throughout additional hospitals), coupled with the strong sequential product revenue growth from that country, is highly encouraging in that regard. 

Meanwhile, product margin, at 65% in Q2, was not a particular highlight.  This compares to approximately 68% in Q1 of this year and as well as in Q2 2016.  The mix of direct versus distributor sales was cited as influencing product margin.  The good news is that there is nothing indicating fundamental shrinkage in margins and management is guiding for product margin to potentially grow to 70%.  We continue to model incremental widening through the course of the out-years in our model from a combination of opportunistic pricing power and volume-related production efficiencies.  
Operating expenses we $4.5M - while this is $1M higher than Q1, almost all ($799k) of the difference relates to non-cash stock compensation - and the increase in stock comp relates to pre-determined operational milestones that were met during the quarter.  Excluding the increase in stock comp, operating expenses were $3.6M, marginally lower than our $3.8M estimate.

While R&D expense, at $488k, remains relatively low given 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 $1.9M and $3.9M ($1.6M and $3.1M ex-changes in working capital) in the three and six months ending June 30, 2017.  Cash balance, recently bolstered by the $10.3M (net) equity raise in April and the more recent $5M draw on their term loan, was $16.4M at Q2 quarter-end.  Management expects cash balance to fund operations through, at least, the end of 2018.  
Operational Update:  Sepsis On Radar, CAR-T Cancer Opportunity, Optimizing REFRESH II Trial Design

Sepsis:  While we think cardiac surgery is still the initial focus for U.S. development, management spent much of the conference call talking about the potential opportunity CytoSorb may have in the treatment of sepsis, including where other novel drugs and devices have failed.  One of possible underlying theme to the high failure rate has been the difficulty in demonstrating consistency in outcomes due to the heterogeneous nature of the condition.  As we have indicated in our prior reports, history has shown that a shotgun approach to enrolling a pivotal sepsis study is likely a recipe for a big waste of money - that is something that CTSO recognizes and clearly is committed to avoiding.  We have and continue to interpret that management's approach towards sepsis will be very systematic and that they will continue to conduct OUS sepsis-related studies to help flesh out potential patient populations in which CytoSorb appears to be most effective - which would presumably improve the chances of success and which may afford a relatively small (potentiall pivotal sepsis study.  

REFRESH:  On June 1st, Dr. Eric Mortensen, MD, PhD joined CTSO as their new Chief Medical Officer.  He is now in charge of leading the clinical programs including the U.S. cardiac surgery studies.  There was not much in the way of an update related to the REFRESH studies on the Q2 call although Dr. Chan did say that they intentionally delayed an IDE submission to FDA for REFRESH II in order for Dr. Mortensen to get up to speed on the REFRESH I data and to optimize the REFERESH II design to increase chances of eventual success.  Management noted that they expect to provide more information about the study protocol in the future and still anticipate REFRESH II kicking off before current year-end.  Refer to the link to our full report (below) for a REFRESH refresher and our related commentary. 

CAR-T Cell Cancer Therapy Opportunity: the feasibility of CytoSorb as a treatment for cytokine release syndrome (CRS) could soon become more clear given the impending PDUFA date (Sept / Oct) of CTL019, Novartis' CAR-T cell candidate for the treatment of an aggressive form of leukemia.  In July an FDA advisory panel voted unanimously to approve the immunotherapy which demonstrated such extraordinarily efficacy in clinical studies that a member of the panel noted that it was the most exciting thing he had seen in his career.  The compromise, however, was that clinical studies also showed the drug elicited severe CRS (i.e. severe inflammatory response with excessive and harmful levels of cytokines) in up to 47% of patients.  CRS can result in serious complications and lead to organ failure and death.  While we think it is almost a certainty that FDA will approve CTL019, NVS will still need to have a toxicity-mitigation strategy.   

While corticosteroids and tocilizumab have been used with some success in controlling CRS, there are drawbacks. This includes that corticosteroids are suspected of potentially comprising immunotherapy efficacy. Relative to tocilizumab, researchers have noted that its use should be avoided if macrophage activating syndrome (MAS) is suspected.   Interestingly, CytoSorb has been used successfully in several patients with a condition called hemophagocytic lymphohistiocytosis (HLH) - one of these was the subject of a case report published in early March 2017 in the Journal of Clinical Immunology.  Studies have shown that subjects with secondary HLH, which is often caused by virologic infection and characterized by a strong and sometimes uncontrollable immune response including CRS, can exhibit responses similar to cancer patients treated with certain immunotherapies.  The similarity in CRS response in HLH and cancer patients treated with immunotherapies and CytoSorb's early success in treating HLH patients (via reduction in inflammatory markers) is encouraging, particularly as it may relate to mitigating the toxicity of CTL019 and similar therapies that could come to market (Kite's KTE-C19 is also awaiting FDA approval).  Another factor that could play in CTSO's favor is the fact that Dr. June Carter, who recently joined CytoSorbents' scientific advisory board, also led the CTL019 program at the University of Pennsylvania.  'Next-steps' towards pursuit of this potential opportunity may become more clear following FDA approval of CTL019.  Given the extraordinary efficacy already seen with CTL019 and the recent and growing massive inflow of investment dollars targeting immunotherapy development, this is an application that we think, if validated, could hold enormous growth potential for CTSO.  Stay tuned.  


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