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CTSO: Q2 19: Product Sales Rebound to Record High Despite Distributor Hangover. Value-Inflection Opportunities Abound

By Brian Marckx, CFA

NASDAQ:CTSO | NYSE:FMS

READ THE FULL CTSO RESEARCH REPORT

Recent Highlights

Record Revenue, Margins: Q2 set records on Product Revenue, Total Revenue, Direct Sales and Product Margin. And this is despite lack of significant ordering from three key distributors. CytoSorbents (CTSO) expects all three to be back online by year-end (one of which resumed ordering in Q2). Product margins, expected to widen to 80% by Q4, are benefitting from growth in direct sales (proportionally as well as in aggregate) and new, more efficient manufacturing facility

CE Mark Renewal: on August 15th, CytoSorbents announced that they received renewal of its European Union CE Mark through May 2024, ensuring no interruptions to international commercialization

REFRESH 2-AKI: more than 25% enrolled as pace accelerates from 12 to 15 patients per month. Guiding to reach 50% mark (i.e. 200 patients) by Q1’20 and, if all goes to plan, make PMA filing by ~mid-2021. Continued progress in REFRESH 2-AKI is what represents the most significant potential pipeline-related value enhancement in our opinion

REMOVE: rapid enrollment pace continues with 222 patients (of planned 250) through. Guiding for enrollment to complete by year-end. Data analysis to follow. Guiding for topline data by mid-2020 – which we think will represent a potential value-inflection event in CTSO’s share price

Data Published: volume of published data continues to grow – including REFRESH I data which was recently published in the journal Seminars in Thoracic and Cardiovascular Surgery. We have and continue to believe clinical evidence represents a major catalyst to driving awareness, adoption and utilization of CytoSorb (in a variety of indications)

Commercialization Footprint Expanding: CTSO’s footprint continues to grow and now encompasses 58 countries – and counting. Regulatory clearances anticipated in S. Korea and Mexico, both substantial markets. CTSO’s direct territories recently increased to 10. Direct sales bring enhanced margins, as well as other benefits

HemoDefend U.S. Clinical Trial: CTSO expects to make an IDE filing this year seeking U.S. regulatory approval to commence a pivotal study for HemoDefend. Study could begin and finish by mid-next year and, if all goes smoothly, HemoDefend could be on the U.S. market shortly afterwards. Progress on this pursuit also holds value-inflection opportunity in our opinion

Q2 2019: Product Sales Rebound to Record High Despite Distributor Hangover. Value-Inflection Opportunities Abound…

CytoSorbents (CTSO) reported financial results for their second quarter ending June 30th and provided a business update. Encouragingly, not only did product sales strongly rebound from the relative weakness in Q1 to set a record high (of $5.85M, +12% yoy, +28% qoq) but did so despite continued lack of significant ordering from three of the company’s most important distributors. As a reminder, while Q1 product sales increased modestly yoy, they were lower than each of the final three quarters of 2018 (including a 16% drop from Q4). That weakness was largely attributed to inventory rebalancing by three of CTSO’s distributors, including Fresenius (FMS).

Management noted on the earnings call that while one of the three resumed purchasing in Q2, that had they not, product sales would have still been a record high. We think this is at least partially attributable to the company’s incremental shift towards ‘owning’ a greater portion of the sales channels, which can have several benefits including higher margins. This is reflected in the record high of direct (as opposed to third-party) sales in Q2, which increased 13% yoy and 14% qoq to $4.5M, accounting for 78% of total product sales. Importantly, the company continues to expect the other two distributors (which includes Fresenius) to resume ordering before year end. Also noteworthy as it relates to product sales reaching a new record, is that this was achieved despite a meaningful foreign exchange headwind, which took a $357k bite (or ~6% of product sales) off of the topline.

In addition to resumption of ordering from these distributors, 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. HemoDefend, a U.S. pivotal study for which could begin in the coming months, represents another potential near-term catalyst.

And despite the dip in sales in Q1’19, product revenue through the first half of the year is up nearly 8% to $10.4M. This is just 1% lower than product sales in the second half of 2018 and higher than any other consecutive two-quarter period. And it is not just product sales and total revenue (which, at $6.2M, was also a new high) that were financial highlights as product margin, which came in at 76% in Q2 and averaged 75% through 1H’19, similarly set new highs (on a quarterly and two consecutive quarters bases). Management continues to guide for product margin to reach 80% on a quarterly basis by year end.



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, 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 Republic), and assignment of dedicated reimbursement in Switzerland. In addition, management continues to anticipate being in a position to file an IDE to FDA (following successful requisite bench testing) for a pivotal study of HemoDefend by the end of 2019. Given a relatively straightforward FDA pathway, CTSO believes that (assuming all goes well) HemoDefend could launch in the U.S. by late next year. Management talked about the design of the intended U.S. pivotal study for HemoDefend on the Q2 call, which we include below. We reiterate that 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 (beyond their initial REFRESH / acute kidney injury program).

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 continues to enroll very rapidly. Current enrollment (i.e. as of August 6th) stands at 222 patients across 15 trial sites. This is up from 180 patients (also across 15 sites) as of May 3rd and from 130 patients (at 13 sites) as of March 7th. While this indicates that the pace of enrollment slowed over the last few months, that may be reflective of the typical summer seasonality in healthcare procedural volumes, which often decline during summer months. Management is guiding for full enrollment (n=250) to complete before current year-end and, given the potential that it accelerates into the Fall, we think it is possible that the final patient runs through by early-to-mid Q4. Data analysis will follow and, if all goes well, management believes they could be reporting topline data of REMOVE by mid-2020.

Given the potential significance of the data as it relates to validating the safety and utility of CytoSorb in this indication (and resultant effect on spurring additional adoption and use of the device in currently-marketed territories) as well as the possible implications for U.S. regulatory purposes, we expect that this REMOVE data readout will represent a potential value-inflection event in CTSO’s share price – and, as such, will be something that we will be eagerly awaiting.

REFRESH 2-AKI is also moving along and has accelerated since the protocol amendment was approved in September 2018. The study is now more than 25% completed with 109 patients enrolled (as of August 6th), which is up from 79 as of early May and 56 in early March. There are 24 sites active (up from 23 in May) and others that should come online over the coming months. Rate of enrollment has increased from about 12 per month in the Spring to 15 per month over the last two months – which is particularly encouraging given the typical summer slowdown in elective procedures. CTSO anticipates eventually having 30 to 35 sites active, which should further facilitate the pace of enrollment – which management believes can increase to ~20 patients/month (which is consistent with the current patient/site/month enrollment rate assuming ~32 sites active).

The company continues to guide for hitting the 200-patient mark by Q1 2020 – at that point, which will represent 50% of total expected enrollment, an interim analysis will be completed. Assuming no unexpected issues from that analysis and pace of enrollment reaches ~20/month, CTSO anticipates enrollment will complete by the end of 2020. If all goes to plan, CTSO believes they can have data analysis completed and a PMA application submitted to FDA by ~mid-2021. While we think that timeline leaves little-to-no room for unexpected delays and may be somewhat aggressive (although not unrealistic), if this ends up being pushed back by several months or even quarters from what management is proposing here, it would be largely immaterial from a valuation perspective in our opinion (given the relatively meager estimated cash burn rate at that time, particularly in relation to the commercial upside that would result from U.S. regulatory approval).

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 80% and 65% 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 – which could happen either late this year or early next. 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
Q2 total revenue was $6.2M, a new record, up 8% yoy and +20% sequentially. Product revenue was $5.9M (+4% vs. $5.7M E), also a record high, up 12% yoy and +28% from Q1’19. As noted, Q2 revenue records were achieved despite continued lack of significant ordering from three of the company’s most important distributors. Management noted on the earnings call that while one of the three resumed purchasing in Q2, that had they not, product sales would have still been a record high. Importantly, the company continues to expect the other two distributors (which includes Fresenius) to resume ordering before year end. Also, noteworthy as it relates to product sales reaching a new record, is that this a foreign exchange headwind negatively affected sales by $357k (or ~6% of product sales).

Meanwhile, grant income remains significant and was $382k (vs. $515k E) in Q2. 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 substantial. Of the remaining ~$3.1M available under their current roster, we model ~$935k to be billed during the rest of 2019, including $475k in Q3.

Relative to product sales, Germany continues to account for the majority, contributing 63% in Q2 and 65% in 1H’19 (compared to 58% for the full year 2018) and accounting for 78% and 81% of direct sales in those respective periods (compared to 81% in FY2018). Sales from Germany grew 14% yoy and were up 19% on a sequential basis through Q2’19. Q2 also set a record on direct sales, which were $4.5M. Direct sales have climbed as a proportion of total product sales – increasing from 72% in FY2018 to 78% and 82% in Q2’19 and 1H’19, respectively. Total direct sales grew 13% yoy and 14% qoq – slightly less than the growth in Germany and reflecting less robust sales from the U.S. and other (non-itemized) countries. 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 eventual entry into Mexico and South Korea via the Fresenius co-marketing agreement will bring the total distribution footprint to more than 58 countries, compared to 53 one year ago and 44 two years prior. In mid-August CTSO announced the latest additions to their international footprint with their expansion into Brazil, Colombia and Costa Rica which have combined populations of more than 250M people. CytoSorb has been used in a host of conditions throughout much of the world. To-date CytoSorb has been used in more than 67k human treatments, up from 46k a year ago. Current utilization (based on our crude calculations) is now averaging approximately 2,000 per month and we expect that both aggregate and rate of utilization will continue to climb.

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. More importantly, there is little doubt in our minds that utilization is begetting more utilization – and the reasons likely almost universally relate to the ever-growing amount of evidence supporting the utility (i.e. safety and effectiveness) of CytoSorb in various critical care applications. As many more of these experiences – from single-patient case studies to relatively large, formal, randomized controlled studies – are now making their way into published manuscripts in leading industry journals, we think this will bode exceptionally well for generating additional awareness of CytoSorb and translating into greater adoption and utilization.



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 76% in Q2’19 and 75% in 1H’19, setting records for each respective period and up from 74% in both Q2’18 and 1H’18. Recent activation of the new (more efficient) manufacturing facility and proportionally greater (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 fell slightly on a yoy basis but increased as compared to Q1’19. Operating expenses, which included about $150k worth of non-cash stock compensation, were $8.0M in Q2’19, compared to $8.2M (including ~$2M in stock comp) in Q2’18 and $7.7M (including ~$230k in stock comp) in Q1’19. 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 63 people, up from 40 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 $3.1M and $7.4M ($3.5M and $7.3M, ex-changes in working capital) in the three and six months ending 6/30/19, compared to $3.3M and $5.5M ($2.3M and $5.0M, ex-changes in w/c) in the comparable prior year periods. Cash balance, pro forma for the July 2019 Term loan ‘B’ $5M draw, was approximately $21M at quarter end. The Term loan B draw also had the effect of extending the interest-only period on the total o/s debt facility (which now stands at $15M) from November 1, 2019 (previously) to April 2020 (or later, if they meet certain revenue tests are met). Management anticipates the current cash balance to be sufficient to fund operations “well into 2020.”

We cover CTSO with a $13.75/share price target. See link for free access to our updated report on the company.

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