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CTSO: Distributor Sales Take a Breather But Expected to Rebound. Direct Sales Remain Robust

05/09/2019
By Brian Marckx, CFA

NASDAQ:CTSO

READ THE FULL CTSO RESEARCH REPORT

Q1 2019 Update: Distributor Sales Take a Breather But Expected to Rebound. Direct Sales Remain Robust

CytoSorbents (NASDAQ:CTSO) reported financial results for their first quarter ending March 31st and provided a business update. While grant revenue was inline with expectations, product sales were a relative dud. While up 3% yoy, product sales fell 16% sequentially as three of the company’s most significant distributors significantly cut back their purchases. One of these was Fresenius – which, given the reallocation in Q1 of Poland, Sweden, Denmark and Norway from Fresenius-exclusives to CTSO-direct (more specifically, to co-marketing), may have in hindsight signaled a potential short-term disruption in sales from these countries (as Fresenius may have slowed ordering for these territories and CTSO’s direct operations there had yet to become fully operational). The other two (unnamed) distributors apparently decided to sell through some of their inventory before reordering.

The good news is that direct sales, which accounted for 72% of total product revenue in 2018, remained relatively robust. Direct sales grew 18% yoy and 5% sequentially through Q1’19. Moreover, based on management’s comments on the call, distributor sales should return to growth in short-order and, coupled with CTSO’s sales resources coming online in their new territories (as of April 1st), product revenue in Q2 should “return to our historical growth trajectory and are anticipated to the highest quarterly product sales reported in our history”.

And we continue to see other catalysts either having an initial influence on sales or making a more significant impact. This includes Fresenius entering Mexico, S. Korea and the Czech Republic (as new exclusive territories), assignment of reimbursement amount in Switzerland (possibly by current year-end), expansion into other countries (including Israel, where CytoSorb was recently granted marketing approval) growing awareness of the potential utility of CytoSorb in various indications and adoption driven by case studies, investigator-initiated studies, KOL interest and (potentially positive results of) the ongoing REMOVE and REFRESH 2-AKI studies.

And while the topline did not impress in Q1, there were some positive financial-related highlights in the quarter. That includes product margin holding up well at 74% (and still expected to grow to ~80% on a quarterly basis by the end of this year) and operating loss inline with our $4.3M estimate - which is despite a 19% miss on product sales and initial investments related to the expansion of the direct sales force. And while we have made some downward revisions to our topline forecasts, our out-year EPS are not significantly changed and we continue to show initial GAAP operating income in 2021. Our price target nudged down from $15 to $14.5/share.

And, importantly, CTSO continues to make substantial progress on the operational front. That includes accelerating the pace of enrollment in both their REMOVE (German infective endocarditis) and REFRESH 2-AKI (complex cardiac surgery) studies and (as noted) ), the addition of five new direct sales territories (Poland, Sweden, Denmark, Norway and the Netherlands) and three new FMC countries (S. Korea, Mexico and Czech Reoublic), and assignment of dedicated reimbursement in Switzerland. In addition, management now expects to file an IDE to FDA for a pivotal study of HemoDefend by the end of 2019. As we explain below, we think the potential for HemoDefend should not be underestimated.

As it relates to REMOVE, CytoSorbents announced in early February that the Data Safety Monitoring Board overseeing the study recommended that it continue. Their recommendation was based on an evaluation of the first 50 patients. The assessment, which included 28 patients in the CytoSorb cohort and 22 in the control group, analyzed cytokine and vasoactive mediator levels as “an indicator of the mechanistic mode of action” and found no device-associated adverse events in the CytoSorb group.

As a reminder, REMOVE is evaluating 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 (an already-completed 39-patient case study already indicated potential utility of CytoSorb in infective endocarditis, a growing problem among IV drug users which share dirty needles) – 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.

This DSMB 50-patient evaluation was a critical milestone as not only does it indicate there are no serious safety concerns, but its success was also a prerequisite for the German government to continue funding the study. And it holds potentially even greater importance when considering that success of REMOVE could eventually inform or even help dictate the company’s U.S. regulatory and commercialization decision-making.

Management recently noted that, given the robustness of the trial design, that it might be possible to use REMOVE as primary support (assuming positive results) for a future FDA filing for an infective endocarditis indication. As we noted in our recent update on CTSO, 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.

REMOVE is enrolling very rapidly. Current enrollment stands at 180 patients across 15 active sites. This is up from 130 patients and 13 sites as of March 7th and 63 patients as of November 6th. This indicates that the pace of enrollment has increased from approximately 17 to 25 patients per month over the last couple of months. Assuming this pace holds, total enrollment of n=250 could happen by the end of Q3 (or potentially sooner).

REFRESH 2-AKI is also moving along, although not nearly at the same pace as REMOVE. Part of the reason was the protocol amendment, the wait for approval of which all but stunted patient screening. But, with the amendment approved in September, enrollment appears to have picked up and currently stands at 79, up from 56 two months prior and from 20 in early November. The number of trial sites has similarly increased, up from 21 in March to 23 today, which has facilitated an increase in the rate of enrollment from about 9 patients per month to approximately 12 currently. Another six sites are on-deck and expected to come online in the near-term. CTSO hopes to have a total of 200 patients through the study by the end of Q1 2020 – which, based on the current enrollment rate, appears very doable.

CTSO continues to build out their geographic footprint. That includes their direct sales territories, distributor-detailed areas and countries in which they have a presence through their Fresenius co-marketing arrangement. As it relates to their direct territories, CTSO recently added five new countries; Poland, Sweden, Denmark, Norway and the Netherlands, bringing the total number of countries where they detail direct, to ten (which also includes Germany, Austria, Switzerland, Belgium and Luxembourg). These new five countries have aggregate populations roughly equal in size to that of Germany, which currently accounts for approximately 81% and 58% of direct and total product sales, respectively. As sales made through their own sales force come at wider margins, this proportional expansion of their direct-sales footprint should benefit product margins and (at least eventually) overall profitability.

Meanwhile, Fresenius will begin selling in Mexico and South Korea through the co-marketing partnership with CTSO whereby the dialysis giant has exclusive rights to distribute CytoSorb for acute care and other hospital applications. Combined, these two countries have populations of approximately 180M people. Sales will commence following obtainment of regulatory clearance in those countries. Fresenius also has exclusive distribution rights in the Czech Republic and Finland and for all critical care and ICU applications on dialysis or ECMO machines in France.

Financials…
Q1 total revenue was $5.2M, up 5% yoy and down 15% sequentially. Product revenue was $4.6M (vs. $5.6M E), up 3% yoy and down 16% from Q4’18. Grant income remains robust and was $615k (vs. $606k 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 ~$3.5M available under their current roster, we model ~$1.4M to be billed during the rest of 2019, including $515k in Q2.

Relative to product sales, Germany continues to account for the majority, contributing 68% in Q1 (and 58% for the full year 2018) and accounting for 78% of direct sales (81% in FY2018). Sales from Germany grew 16% yoy and were up less than 1% on a sequential basis through Q1’19. Meanwhile, total direct sales grew 18% yoy and 5% qoq – slightly better than the growth in Germany and reflecting a more robust % increase in sales from the U.S. and other (non-itemized) countries. And, with the new direct territories coming online, we could see direct sales growth steepen even further.

Much of the recent growth has been attributed to improved reimbursement in Germany and expanding use and utility of CytoSorb to address a growing list of critical care conditions. 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. At least 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. Switzerland could soon provide another catalyst to product sales as a dedicated procedure code for cytokine reduction went into effect on January 1, 2019. Assignment of a reimbursement amount is next, which could happen by the end of 2019. While Switzerland is only about 10% of the size of Germany (in population), if CTSO’s direct-sales successes can be replicated there, we estimate incremental annual product revenue could be as much $1.2M.

Expansion of the geographic and distribution footprint as well as increasing commercial use in a growing number of ‘indications’ have also benefitted product revenue. The recent addition of the five new direct sales territories and entry into Mexico and South Korea via the Fresenius co-marketing agreement brings the total distribution footprint to 55 countries, compared to 45 one year ago and 32 two years prior. CytoSorb has been used in a host of conditions throughout much of the world. To-date CytoSorb has been used in more than 61k human treatments, up from 40k a year ago. The recent indication for removal of bilirubin and myoglobin could have the effect of further expanding use. While CE Mark meant that clinicians had wide discretion in what conditions to employ CytoSorb, this label expansion adds credence for use in these specific indications. Additionally, it can provide a reimbursement benefit related to on-label (as opposed to, previous, off-label) use for these conditions. Further label expansion for use in additional indications could follow.

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). We think CTSO will continue to look to monetize the successes of these grant-funded studies with further label extensions and in the development of new technologies (such as HemoDefend). That could provide additional optionality in terms of commercial programs that CTSO could pursue. CTSO’s most recent grant award, $3M related to further development of HemoDefend, came in August 2018. This is an extension of previous grants and expected to fund a pivotal U.S. study for HemoDefend. As we explain below, we think HemoDefend may be a dark horse that is mostly being overlook by investors and the significance of continued development progress should not be underestimated.

Relative to expenses and margins…product margin was 74% in Q1, which compares to 74% and 75% in Q1’18 and FY2018, respectively. Activation of the new (more efficient) manufacturing facility and increasing (higher margin) direct sales should further bolster product margins. Management continues to guide for product margins to reach 80% on a quarterly basis this year. We currently model full year 2019 product margin of nearly 77%, or ~300 basis points better than 2018.

Meanwhile operating expenses increased on a yoy basis but fell as compared to Q4’18. Operating expenses, which included about $230k worth of non-cash stock compensation, were $7.7M in Q1’19, compared to $6.5M (including $525 in stock comp) in Q1’18 and $9.6M (including $1.6M in stock comp) in Q4’18. An increase in headcount and other ‘investments’ has contributed to the recent increase in operating expenses. The direct sales force (including support staff) now stands at 52 people, up from 35 one year ago. While operating expenses have increased, these ‘investments’ are expected to result in steepening of the revenue and, eventual, earnings curve.

Cash used in operating activities was $4.2M ($3.8M, ex-changes in working capital) in the three months ending 3/31/19, compared to $2.2M ($2.5M, ex-changes in w/c) in Q1’18 and $2.7M ($3.2M, ex-changes in w/c) and Q4’18. Cash balance was $19.7M at the most recent quarter-end. Debt maturities within one-year are $1.7M. Management anticipates the current cash balance to be sufficient to fund operations into 2020.

We cover CTSO with a $14.5/share price target. See link for free access to our updated report on the company.

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