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CTSO: Q1 2018 Update: Product Sales New Record. REFRESH 2 Enrollment Should Pick Up Steam. REMOVE Already Ramping

By Brian Marckx, CFA


CytoSorbents (NASDAQ:CTSO) reported financial results for their first quarter ending March 31st and provided a business update. Product sales, while a hair below our estimate, continue to climb with Q1 marking the 11th consecutive quarter of setting a new high. Product sales growth is broad based – with both direct (i.e. via CTSO’s sales force) and distributor sales posting very strong double-digit yoy growth. Meanwhile, product margin, at 74%, was second highest on record.

Importantly, these trends are expected to continue. CTSO is guiding for product sales to increase sequentially (i.e. Q1 to Q2), product margin to benefit from higher production volumes (facilitated by on-lining of a new manufacturing facility) and for operating income (ex non-cash and clinical trial expenses) to move into the black (for the first time) on a quarterly basis during 2018. Management has noted that they estimate this is achievable at a quarterly product revenue run-rate of approximately $5.5M – which is about $200k more than what we model for product sales in Q4 of this year – that may suggest that our model may prove conservative.

Growth of the direct sales force, onboarding of additional third-party distribution and increased activity from CTSO’s partners have all contributed to adoption and utilization of CytoSorb and the resultant product sales growth. CytoSorbents has now been used in more than 40k human treatments, up (74%) from 23k one year prior.

Much of the growth is coming from CTSO direct sales efforts. Headcount of the direct sales team increased by more than 50% over the last 12 months and resulted in direct product sales growing 80% yoy. Direct sales accounted for 76% of product sales in Q1, up from 72% in the prior year – the proportional increase in direct sales likely contributed to the ~600 basis point widening in product margin over the same period.

As we have stated in recent prior updates, while we reiterate the potential for short-term volatility in product sales, we think the additional history of regular growth should provide ever-increasing confidence of the robustness of the fundamentals of the source and ‘quality’ of these revenues in the context of long-term prospects. Re-orders from existing customers, initial orders from new customers, accounts and territories, use of CytoSorb for additional indications and ramping utilization numbers are all common themes that management cites in relation to the source of product sales growth. Bulk orders and inventory-stocking are not. We continue to like near and long-term prospects for product sales growth, the latter particularly so in the context of potential eventual entry into the U.S. market.

Q1 total revenue was $4.9M, up 58% yoy and 6% sequentially. Product revenue was $4.4M (vs. $4.6M E), up 71% yoy and +3% from Q4 ’17. Grant income remains robust and was $491k (vs $420k E) in Q1. While we expect additional (and near-term) opportunities to score future grants, the yet-to-be billed portion of CTSO’s current grant contracts is still significant. Of the remaining ~$2.9M available under their current roster, we model ~$1.6M to be billed during this year (and most of the remainder in 2019).

Relative to product sales, much of the recent 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.

Expansion of the geographic and distribution footprint as well as increasing commercial use in a growing number of ‘indications’ have also benefitted product revenue. Most recently, distribution was expanded to Malaysia – a territory that will be handled through CTSO’s partnership with Biocon, which is also actively engaged in promoting use in investigator-initiated studies. CytoSorb is now distributed in 45 countries and has been used for a host of conditions in commercial clinical practice and clinical studies, including more than 60 investigator-initiated studies. Publicity (and potentially interim updates) from REFRESH II, enrollment which kicked-off earlier this year (following FDA IDE approval in December ’17), as well as from REMOVE (i.e. large, Germany-based RCT in infective endocarditis) which is already rapidly enrolling, could also help drive awareness and adoption of CytSorb overseas.

Meanwhile, grant income continues to help subsidize R&D as well as providing additional validation of CTSO’s technology (particularly given the list of contracts has continually grown). These also may presumably result in new technology that could provide some optionality in terms of commercial programs that CTSO could pursue – a frontrunner in that regard may relate to HemoDefend.

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 2017. This includes funding of up to $999k over two years ($400k of which has been paid to-date) 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 ($108k of which has been paid to-date) and relates to novel hemoadsorptive therapies for severe burn injuries. Then in September ‘17 a phase II SBIR contract worth up to $1M over 29 months ($32k paid to-date) 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.

Product margin, at 74% was second best in history and up from 68% in Q1 ’17. While product margin fell from (the record) 78% in Q4 ‘17, we had anticipated short-term variability as a result of sales mix and order sizes. Q1 product margin was well ahead of our 70% estimate. While production volumes have already contributed to widening of product margins (which have expanded 1,200 basis points over the last two years), the impending opening of a new manufacturing facility is expected to create even greater economies of scale. Management expects the facility to come online in Q2 and is guiding for product margins to eventually eclipse 80%.

Operating expenses were $6.5M in the most recent quarter, compared to $3.4M in Q1 ’17 and $7.2M in Q4 ’17. On a yoy basis, R&D has nearly quadrupled, largely as a result of REFRESH II activities. We model R&D expense to show flat-to-incremental growth over the next 3 – 6 months but then to steepen again with anticipation of ramping REFRESH 2 enrollment. Meanwhile, SG&A expense was largely flat on a sequential basis and up about $1.7M yoy – much of the increase we attribute to growth of the sales force and ramping product sales. But while on an aggregate basis SG&A has significantly climbed, CTSO is already generating some operating leverage as SG&A as a percentage of product sales has fallen from 114% in Q1 ’17 to 106% in Q1 ’18. As noted, management is guiding for operating income (ex non-cash and clinical trial expenses) to land in the black on a quarterly run-rate basis this year – increasing leverage in SG&A/product sales indicates that they are well on their way to getting there.

Cash used in operating activities was $2.2M ($2.7M, ex-changes in working capital) in Q1 ’18, compared to $2.0M and $410k ($1.5M and $1.8M, ex-changes in working capital) during Q1 and Q4, respectively, of last year. Cash balance was $21M at Q1 ’18 quarter end. In March CTSO restructured terms of their $10M loan (principal of which would have begun to amortize), which is now interest-only for 18 months (or for 24 months upon drawing the available $5M “B” tranche) – this will provide a little bit more runway and, per our estimates, get CTSO to at (or nearly at) a point of GAAP operating profitability by the time principal begins payback.

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


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