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CTSO: Q4 2017 Update: Q4 / FY Product Sales +64% / 63%, Product Margin Jumps 900bp. FDA Pivotal Study Underway

03/19/2018
By Brian Marckx, CFA

NASDAQ:CTSO

CytoSorbents (NASDAQ:CTSO) reported financial results for their fourth quarter ending December 31st and provided a business update.  Product sales continue their regular and rapid climb upward, setting another record and besting the prior high (Q3 2017) by almost 25%.  Product sales were also ahead of our (pre pre-announcement) estimate by more than 27%.  Q4 also marked the third consecutive quarter that product sale reached a new peak, following a slight (<1%) dip 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.

As we noted in our Q3 update, indications (including rates increasing by as much as 100% in some locations as well as feedback from some of CTSO's key German accounts) were that the reimbursement issue was indeed proving to be just a short-term hiccup.  Certainly the fact that product revenue grew from $2.62M in Q4 ’16 to $4.30M in Q4 ‘17, or 64% yoy, also supports that theme.

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 (35k human treatments to-date, up from 20k one-year ago) 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.    

Financials…
Q4 total revenue was $4.7M, up 51% yoy and 22% sequentially.  Product revenue was $4.3M, up 64% yoy and +25% from Q3 2017.  Grant income was $351k (vs $400k E).  For the full year, product and total revenue were $13.4M, up 63%, and $15.2M, up 59%.  

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.  Grant income was $1.8M in 2017, an increase of 34% from $1.3M in 2016.  Excluding the DARPA (sepsis-related) award, which was fully paid as of Q2 2017, grant income increased almost 57% over the same period.  Perhaps, even more telling of the implied growing interest in CTSO’s technology from various U.S. government agencies is that grant revenue was never higher than it was in 2017 – and that’s true even if stripping out (the small) DARPA-sepsis grant contribution.  The DARPA grant was the company’s first major government contract (awarded August 2012, $3.8M, five years) and, coupled with more and more real-world clinical evidence supporting the utility and safety of CytoSorb, acted as a harbinger of more to come.    

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 – 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 ($280k 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 ($72k of which has been paid to-date) and relates to novel hemoadsorptive therapies for severe burn injuries.  Then in September a phase II SBIR contract worth up to $1M over 29 months ($0 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.    

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.  CytoSorb is now distributed in 45 countries, up from 32 two years ago, 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, an IDE for which FDA approved in December 2017, could also help drive awareness and adoption of CytSorb overseas.    

Product margin, at 78%, was not only the highest in history, it was 900 basis points better than prior best (69% in Q3 ’17).  Mix of direct versus distributor sales, as well as some benefit from manufacturing efficiencies, have been cited as benefitting product margin during the year, which averaged 71% in 2017, up from 67% in 2016.  With a new manufacturing facility slated to come online in Q2 2018, management expects efficiencies to result in further improvement in product margin.  

Operating expenses were $7.2M and $19.5M in Q4 and the full year 2017, compared to $6.4M and $17.1M in the comparable prior year periods.  R&D expense jumped quite substantially on a sequential basis - from $538k in Q3 ’17 to $2.4M in Q4.  While ~39% ($728k) of the increase relates to non-cash stock comp, R&D expense may remain close to this level going forward (which was largely inline with our expectations) given personnel additions and impending ramping of REFRESH II activities.  Meanwhile, we continue to model SG&A 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.  Management is now guiding to reach quarterly operating profitability, excluding clinical trial costs and non-cash expenses, during 2018.    

Cash used in operating activities was $410k and $6.5M ($1.8M and $6.3M, ex-changes in working capital) in the three and twelve months ending 12/31/17, respectively.  Cash balance, bolstered in Q4 by the sale of 267k common shares (via ATM @ $6.58/share avg) which netted ~$1.8M and $677k from the sale of State of NJ R&D tax credits, was $17.3M at year-end.  Management expects this to be sufficient to fund operations into 2019.   

Operational Update:  REFRESH II Starts, German Endocarditis RCT Starts, HemoDefend FDA Program?...

REFRESH II enrollment imminent
As a reminder, REFRESH II is expected to be a pivotal FDA registration study and provide primary support for a U.S. regulatory filing for use of CytoSorb during cardiac surgery.  In December 2017 FDA approved the IDE.  CMS approval was also required and obtained, as was central ethics committee approval.  Per comments on the Q4 call (March 8th) most of the REFRESH I clinical sites will be participating in REFRESH II, with some having already begun screening patients and expected to begin enrolling in the near-term.  

The multi-center, randomized, controlled U.S. study is expected to enroll up to 400 patients (over two years) which are undergoing elective open heart surgery for valve replacement or aortic reconstruction with hypothermic cardiac arrest.  Patients will be randomized to either standard-of-care (i.e. control) or standard-of-care plus dual CytoSorb cartridges (in parallel in a heart-lung bypass circuit).  The primary endpoint, reduction of acute kidney injury (AKI), is outcomes-based.  AKI will be measured by Kidney Disease Improving Global Outcomes (KDIGO) criteria.  Secondary endpoints include time on mechanical ventilation, use of vasopressors, days in ICU, reduction of inflammatory mediators and 30-day mortality. 

Relative to the KDGIO criteria primary endpoint, this is what we found based on our own research…published in March 2012, KDIGO guidelines are an international initiative for the evaluation and management of AKI.  KDIGO guidelines build on already established AKI measures such as RIFLE (Risk, Injury, Failure, Loss of Kidney Function, and End-stage Kidney Disease) and AKIN (Acute Kidney Injury Network) criteria and measure changes in serum creatinine as well as urine output in staging AKI (i.e. 1 – 3 severity scale).  Below is the definition and staging of AKI as per KDIGO guidelines (SOURCE: Kidney International Supplements, KDIGO Clinical Practice Guideline for Acute Kidney Injury. Vol 2, Issue 1, March 2012).

Despite the newness of the KDIGO criteria, it appears to be largely widely accepted in the U.S. for defining AKI.  In addition, clinical studies have demonstrated a significant positive correlation between KDIGO AKI stage and 30-day mortality, including among subjects undergoing cardiac surgery.   

We had a chance to talk with Dr. Chan in January in San Francisco following his presentation at the Biotech Showcase about the REFRESH II trial design, a topic which was also addressed on the Q4 call.  One of the overriding themes is that REFRESH II was designed in such a way to increase odds of reaching statistical significance on the primary endpoint.  Specifically, by enriching with a population at already relatively high risk of AKI (i.e. those already predisposed to known risk factors), it heightens odds that valve replacement surgery (which is well documented as a cause of AKI) will result in AKI.  Obviously, the goal is to demonstrate significantly fewer CytoSorb patients develop AKI versus control (i.e. SOC).  

And while enriching with a narrower patient population may similarly narrow the label if and when FDA cleared, we think that the main focus should first be on hitting singles – that is, get CytoSorb approved for marketing in the U.S. for a “usable” indication (such as this) and expand the label thereafter.  The initial indication would also be another significant step towards demonstrating safety (and build on that from REFRESH I as well as from the 35k+ human uses overseas) – which could help in facilitating off-label use as well as provide support for approval of future FDA studies in other indications (potentially such as for sepsis or infective endocarditis – below).  And in the meantime, OUS product sales may immediately benefit as a result of implied or presumed clinical legitimacy associated with FDA approving the IDE – which can sometimes result in a halo effect and prompt use in the related indication.     

German Infective Endocarditis Study Starts. Follows Recent Published Study Demonstrating CytoSorb’s Utility in I.E.

As a reminder, a manuscript of a retrospective case series involving 39 patients with infective endocarditis undergoing valve replacement surgery using CytoSorb was published in May 2017 in the International Journal of Artificial Organs.  The study (which was the largest study to-date using CytoSorb for patients with infective endocarditis undergoing valve replacement surgery) showed that intraoperative use of CytoSorb was associated with lower mortality as compared to historical data (without CytoSorb use) as well as a meaningful reduction in certain inflammatory mediators (including IL-6 and IL-8), hemodynamic stabilization and reduction in vasopressor requirements.  (See our Appendix in our full report for our discussion of this case report).   

Infective endocarditis, as the name implies, is an infection of the endocardial surface of the heart – which includes one or more heart valves.  It is a result of certain bacteria and other pathogens that enter the bloodstream, which can be highly and rapidly destructive to heart valves and spread to systemic sepsis and septic shock.  Septic shock occurs when infection leads to critically low blood pressure and organ failure.  Rates of infective endocarditis have been on the rise as a result of the recent dramatic growth of intravenous (i.e. dirty needles) heroin use in the U.S.).  

CTSO hopes to further validate use of CytoSorb in this patient population and in December announced that a new, large, randomized clinical study, conducted in Germany, is aimed at doing just that.  The multi-center study, dubbed REMOVE (REvealing Mechanisms and Investigating Efficacy Of Hemoadsorption for Prevention of Vasodilatory Shock in Cardiac Surgery Patients With Infective Endocarditis), is expected to enroll 250 subjects and will evaluate safety and efficacy of CytoSorb in patients with infective endocarditis undergoing valve replacement surgery.  Primary endpoint is the difference in mean SOFA (Sequential Organ Failure Assessment) scores between experimental and control arms.  Secondary endpoints include 30-day mortality, changes in cytokine levels, need for supportive care therapies such as vasopressors, mechanical ventilation, and dialysis, incidence of stroke, and the length of intensive care unit and in-hospital stay. 

This study could be a win-win for CytoSorbents – potentially providing robust evidence of CytoSorb’s utility in a large and growing patient population – and doing so at little or no cost to the company as the study is being fully funded by the German government.  Jena University Hospital is primary sponsor - Jena has been an important partner of CTSO’s over the years and manages the company’s International CytoSorb registry.  B.R.A.H.M.S. (a division of Thermo Fisher Scientific) and the Fraunhofer Institute for Interfacial Engineering and Biotechnology are co-collaborators.  

REMOVE incorporates inclusion criteria of EuroSCORE II ≥ 4.  Higher EuroSCORE II (European System for Cardiac Operative Risk Evaluation II) scores are associated with higher risk of mortality.  For reference, mean and median EuroSCORE II scores among the 39 patients from the earlier case study was 12.8 and 26.0, respectively, - so those were relatively very sick individuals.  While a specific organ function-related measure was not part of that case study, certain parameters associated with organ function and clinical outcomes, were.  The case study showed that CytoSorb-treated patients experienced marked reduction in IL-6 and IL-8, “normalization of lactate and base excess back to preoperative baseline levels within 3 days and hemodynamic stability before, during, and after the operation accompanied by a rapid decrease in need for vasopressors." 

Primary endpoint of REMOVE is change in SOFA score – which is a widely accepted clinical measure of organ function as well as of mortality.  SOFA is based on six different measures; respiratory, cardiovascular, hepatic, coagulation, renal and neurological – many of which were assessed (with favorable results) in the 39-patient case study (see Appendix in full report).  Mortality was also much lower than predicted in the 39-patient case series – also suggesting a CytoSorb-related mortality benefit.  We also note that another recently published study (“Extracorporeal cytokine elimination as rescue therapy in refractory septic shock: a prospective single-center study”, Journal of Artificial Organs, Sept 2017) also showed that CytoSorb treatment was associated with significant reduction in vasopressor requirements, hemodynamic stability, pro-inflammatory mediators and mortality.  We provide this as background as we think it offers context in terms of the potential for eventual success of REMOVE.

REMOVE will be conducted in parallel with REFRESH II, which specifically excludes subjects with infective endocarditis.  As such and assuming success of both studies, CytoSorbents envisions that their device could one day be considered standard of care for the majority of open heart valve replacement surgeries (“hundreds of thousands of procedures worldwide”).  Management noted on the Q4 2017 call that, given the robustness of the trial design, that it might be possible to use it as primary support (assuming positive results) for a future FDA filing for an infective endocarditis indication.  

While it is way too early to guess the chances of that happening, positive results from this German study would certainly lend significant veracity to the likelihood of an eventual FDA approval for a similar indication – whether it requires a U.S study or not.  But, it’s probably no coincidence that the anticipated timelines for REMOVE and REFRESH II are similar – both of which are commencing now and with expected durations of two years. 

HemoDefend
Since 2015, HemoDefend has been the subject of a $1.52M phase II SBIR grant funded by NHLBI (part of NIH) and U.S. Special Operations Command.  The focus of the work (per CTSO’s PR) is to, “help advance the Company's HemoDefend™ blood purification technology towards commercialization for the purification of packed red blood cell (pRBC) transfusions.  That contract followed the successful completion of a phase I SBIR contract which was, “designed to bring the HemoDefend™ in-line blood filter to human testing, a required major step towards commercialization.  In addition, the contract will also fund development of new polymers that could enable safer whole blood transfusions, a potentially life-saving advance in the treatment of trauma and military combat casualty victims.”  

Approximately $640k remains under the phase II contract but CTSO is wasting no time in readying for the subsequent steps towards a goal of commercialization.  Management noted on the Q4 call that they have (informally) met with FDA and, with anticipated support of NHLBI, they expect to commence a pivotal FDA registration study within 12 months.  

The anticipated use of HemoDefend for this application is, per CTSO’s description on the call, “a point of transfusion inline filter focused on reducing non-infectious contaminants that can cause transfusion reactions ranging from relatively mild fever and allergic reactions to very severe transfusion related acute lung injury which is the leading reported cause of transfusion related deaths that occurs in roughly 1 in 1k to 1 in 5k transfusions.”

FDA / DoD Joint Program Aimed at Speeding Approval…
Interestingly, in January 2018 FDA and the U.S. DoD launched a joint program (http://bit.ly/2HDtjTc) to expedite development and evaluation of medical products for emergency care of military personnel.  Specifically, “The FDA is fully committed to working closely with our federal partners in the DoD to expedite availability of medical products essential to the health of our military service members, particularly those products used to treat injuries in battlefield settings,” said FDA Commissioner Scott Gottlieb, M.D. “Ensuring our Nation’s warfighters have safe and effective medical products is a top priority for the agency. By standing up a collaborative program with DoD, we hope to address DoD’s immediate product priorities and ensure these products are developed and made available in the most expeditious manner possible.”

While the initial focus of this program is on biological products, such as preserved plasma and platelets, we think it is a clear indication that FDA is eager to leverage the additional authority provided to it by H.R.4374 (Dec 12, 2017) in expediting approval of medical products for which DoD determines there is a use for in emergency situations.  

Whether or not CTSO can utilize the program for HemoDefend (or potentially for CytoSorb), we do not know.  But it potentially does provide an additional option.  More importantly, however, is that it is becoming increasingly clear that the FDA, under President Trump, believes in more efficient and less cumbersome approval pathways for novel, effective medical products that address unmet needs.   

We cover CTSO with a $12/share price target.  See below for free access to our updated report.

READ THE FULL RESEARCH REPORT HERE.

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