By Brian Marckx, CFA
READ THE FULL CTSO RESEARCH REPORT
Q4 2018 Update: Product Sales +27%, Expenses Jump In Part Due to Investments Aimed at Further Accelerating Growth…
CytoSorbents (CTSO) reported financial results for their fourth quarter and fiscal year ending December 31st and provided a business update. Product and total sales continue their rather consistent climb higher with each setting new all-time highs and benefitting from both new and repeat orders of CytoSorb. Product revenue was driven by strong gains in both direct and distributor sales, the geographic footprints of both of which continue to expand. Meanwhile, product and total gross margin also continue to impress, both widening by several-hundred basis points and reaching new highs in both Q4 and the FY2018. Unfortunately, much of the revenue and margin growth did not flow through the income statement in Q4 as new investments, aimed at further steepening the topline growth, resulted in the largest operating loss in company history. These added expenses and investments, however, are expected to result in positive ROI. Our updated model now shows positive GAAP operating income in our new out-year (i.e. 2021).
The highlights on the operating front in just the last several months include a positive DSMB review (Feb 4th) of REMOVE (Germany-based RCT in infective endocarditis) at the 50-patient enrollment mark, pace of enrollment accelerating in both REMOVE and REFRESH 2-AKI (U.S. RCT in complex cardiac surgery), the addition of five new direct sales territories (Poland, Sweden, Denmark, Norway and the Netherlands) and two new FMC-partnership countries (S. Korea and Mexico), and assignment of dedicated reimbursement in Switzerland.
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. As of the Q4’18 earnings call on March 7th, 130 patients had been brought into the study across a total 13 sites. This is more than double the 63 that had enrolled as of the company’s Q3’18 call on November 6th and implies an average rate of 16 to 17 patients per month. Assuming that pace holds, total enrollment of 250 could happen by mid-Q4 of this year.
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 56, up from 20 four months prior. The number of trial sites has similarly increased, up from 14 in November to 21 today. Another eight are on-deck and expected to come online in the near-term. Back-of-the-envelope says enrollment has averaged about one patient per site every two months (or, 0.5 patients/site/month) over the last several months. CTSO hopes to have a total of 200 patients through the study within the next 12 months – which, based on the current enrollment pace, appears very reasonable (implying a pace of less than 0.6 p/s/m).
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. Management noted on the Q4 call that they are fully staffed in each of these new territories with the exception of Poland, where they expect to have a full sales team in place by next month.
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.
Q4 total revenue was $6.1M, up 31% yoy and +12% sequentially. Product revenue was $5.5M (vs. $5.5M E), up 27% yoy and up 7% from Q3’18. Grant income remains robust and was $610k (vs. $493k E) in Q4. 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 ~$4.1M available under their current roster, we model ~$2.0M to be billed in 2019, including $606k in Q1.
Relative to product sales, Germany continues to account for the majority, contributing 56% and 58% in Q4 and the full-year 2018, respectively and accounting for 81% of direct sales in both periods. This is largely consistent with that country’s proportional contribution in the prior year periods. Sales from Germany grew 48%, from $7.9M the prior year to $11.8M in 2018 – which is actually slightly below the total product sales growth rate of 51% over the same period.
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. 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 56k human treatments, up from 35k 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.
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). The recent label expansion of CytoSorb for the removal of myoglobin, for example, appears to be a direct extension of the rhabdomyolysis clinical study funded by a grant from the USAF. 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 75% and 74% in Q4 and the full year 2018, up from 72% and 71% in the prior year periods. Activation of the new (more efficient) manufacturing facility and increasing (higher margin) direct sales should further bolster product margins. Management is guiding for product margins to reach 80% on a quarterly basis in 2019. We currently model full year 2019 product margin of nearly 78%, or ~400 basis points better than 2018.
Meanwhile operating expenses jumped significantly in Q4, increasing by almost 50% as compared to Q3’18. Stock and other non-cash compensation accounted for about 56% of the $3.2M sequential increase in expenses. An increase in headcount and other ‘investments’ also contributed to the record spend in Q4, although these are expected to result in steepening of the revenue and, eventual, earnings curve.
Cash used in operating activities was $2.7M and $10.8M ($3.2M and $9.9M, ex-changes in working capital) in the three and twelve months ending 12/31/18, compared to $410k and $6.5M ($1.4M and $5.6M, ex-changes in working capital) in the comparable prior-year periods. Cash balance stood at $22.4M at year-end. Debt maturities within one-year are just $667k. Management expects the current cash balance will be sufficient to fund operations into 2020.
Operational Update: REFRESH II Enrollment Accelerates Following Amendment Approval, HemoDefend $3M Grant and FDA Program, New Liver Disease Indication, REMOVE Positive DSMB Rec…
(See our Appendix for background on REFRESH studies, REMOVE study in infective endocarditis and other CytoSorb related programs and indications)
REFRESH II Enrollment Accelerates Following FDA Approval of Protocol Amendment in Sept 2018
In early September CTSO announced that FDA approved the protocol amendment for their REFRESH 2-AKI trial. As a reminder, CTSO mentioned prior to that that their clinical advisors recommended the protocol amendment as it would “expand the inclusion criteria, improve operational aspects of the patient screening process, enhance the rate of enrollment, and ultimately increase the applicable market that CytoSorb could address if approved.”
Specifically, the amendment modified the age and weight patient eligibility criteria, removing the age cap and eliminating a weight restriction. Initial protocol restricted eligibility to only people 18 to 80 years old and of weight 100 to 382 pounds. The amendment removed the 80 year-old cap and completely eliminates any weight restriction. Given that age and obesity are correlated to and risk factors for acute kidney injury, these eligibility tweaks open up the study to a broader population. Management has noted that this has helped facilitate enrollment, which began in April 2018 and had been lagging up to that point.
Since the amendment approval, 48 patients have enrolled. This includes 28, or more than 1.5/week, during the last four months. Total enrollment currently stands at 48. Currently 21 sites have been initiated – up from 14 sites in early November, and another 8 are undergoing start-up activities. As some of these new sites come onboard, we could see the pace of enrollment pick up further. On a per site basis, enrollment has averaged about one patient per site every two months. CTSO has said previously that with all targeted sites active that the pace of enrollment is anticipated to be approximately one patient per site per month. Their most recent guidance (on the Q4’18 call in early March 2019) is to have a total of 200 patients enrolled within the next 12 months – which, based on the current enrollment pace, appears very reasonable (implying a pace of less than 0.6 p/s/m). At this rate, and assuming all eight on-deck sites are activated by mid-2019, full enrollment (n=400) could happen by late-2020 or early 2021.
HemoDefend Closer to Commercialization with New $3M, 3-Year NHLBI Award
With CytoSorb consuming most of the investor interest in CTSO, the potential incremental value of HemoDefend may be under-realized. This is despite successful progression through a phase 1 program (Elimination of blood contaminants from pRBCs using HemoDefend™ hemocompatible porous polymer beads) funded by a $204k grant (awarded Sept 2013) from NHLBI and a follow-on $1.5M phase 2 NHLBI award (pRBCs Contaminant Removal with Porous Polymer Beads). The final $140k of the ph2 award was recognized by CTSO in Q3’18.
In August another NHLBI award was announced. pRBC contaminant removal with hemocompatible porous polymer beads provides up to $1M per year for up to three years (i.e. up to $3M total) and is matched dollar-for-dollar with CTSO’s own funds. CTSO expects this will be used to fund a pivotal FDA clinical trial. While the company had hoped that a pivotal study would begin in Q2 2019 (contingent on FDA IDE approval), that timeline has since been pushed back “due to the sale and loss of key technical personnel at our main parts supplier” (per the Q4’18 earnings release). CTSO noted that they are working with their supplier and, if all goes well, hope to have a pivotal study for HemoDefend underway by the end of this year. We expect we’ll hear updates on the progress of this on future calls.
The potential market for HemoDefend could be fairly enormous. An estimated 80M – 100M blood donations happen each year worldwide with each donation generating multiple blood transfusion products such as packed red blood cells (pRBCs), platelets, fresh frozen plasma, and cryoprecipitate. Every year more than 100M RBC units are transfused, including ~30M in the U.S. Blood can become contaminated either from the donor or during storage as the blood ages. If not removed, contaminants can cause health risks, which can range from mild fever and itching, to potentially life-threatening and lethal reactions. The NHLBI-funded development of HemoDefend focuses on use as an RBC filter for removal of contaminants such as antibodies, free hemoglobin, cytokines, and bioactive lipids in packed red blood cells.
Practical and effective ways to purify contaminated blood and reduce risk of transfusion-related adverse reactions is an objective of NHLBI (100+ related projects are listed in NIH’s Project Information database) as well as the U.S. military and represents a significant current unmet need. As such, the significance of continued development progress of HemoDefend and success under these NHBLI-funded programs should not be underestimated. And certain tangible milestones, such as eventual commencement of a pivotal FDA study, if that happens, should be a wake-up call for investors to pay much more attention to HemoDefend – as we think this program has the potential to create meaningful incremental shareholder value.
More Evidence Supporting CytoSorb’s Utility in HLH
Additional evidence appears to support the potential utility of CytoSorb in the treatment of hemophagocytic lymphohistiocytosis (HLH). 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 cytokine release syndrome (CRS), can exhibit responses similar to cancer patients treated with certain immunotherapies. Severe CRS (i.e. severe inflammatory response with excessive and harmful levels of cytokines), which can lead to serious complications including organ failure and even death, has been associated with the use cancer immunotherapies, including Novartis’ (NVS) Kymriah and Gilead’s (GILD) Yescarta which were recently approved by FDA and in Europe for the treatment of certain blood cancers.
While these immunotherapies have shown extraordinary efficacy, mitigating risk of CRS remains problematic. 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.
Early in 2017 CTSO appeared to be working towards a potential program in HLH / CRS. In Q1 of that year they announced that Dr. Carl June joined their scientific advisory board for the purpose of guiding their strategy inoncology. Dr. June is considered the pioneer of cancer immunotherapy and guided Novartis’ Kymriah program. In March 2017 CTSO disclosed that “we have confirmed the interest in the therapy [CytoSorb], once available, as an adjunct to tocilizumab, and before high dose steroids are administered. We plan to continue to pursue applications of our therapy in the treatment of CRS in the United States, Europe, and elsewhere, as cancer immunotherapies continue to expand worldwide.”
As we noted in early 2017, the similarity in CRS response in HLH and cancer patients treated with immunotherapies and CytoSorb’s apparent early success in treating HLH patients (via reduction in inflammatory markers) was encouraging, particularly as it may relate to the leveraging the massive interest in and growth of the immunotherapy segment. Activity has clearly continued as evidenced by a recent case at Mount Sinai Beth Israel where CytoSorb was successfully used on a patient with poor prognosis and diagnosed with HLH. The case, published in Mount Sinai’s Division of Nephrology publication earlier this year, indicated CytoSorb was used as a last resort when other therapies failed – the ICU team obtained IRB approval to use CytoSorb, following which the “patient’s clinical improvement was immediate and significant, with hemodynamic stabilization during the first treatment, followed by enhanced liver function and mental status.”
The latest update relative to the potential use of CytoSorb for CRS/HLH came on the Q4’18 call (March 2019) with management noting that they are seeing strong interest in both the U.S. and, following approval of Yescarta and Kymriah in Europe, now also in that part of the world. Interest, per their comments, is coming from KOL’s in the immunotherapy space and CTSO has been in close contact with the medical centers that were involved with the approval of these two cancer therapies in Europe. Particularly noteworthy, in our opinion, was management mentioning that there is strong interest to evaluate CytoSorb among the hospitals that are authorized to administer these therapies. In addition, CTSO noted that there is interest to collaborate with the company on clinical studies, particularly as a rescue therapy in cases where patients with CRS/HLH fail first line therapies such as tocilizumab and steroids. Further progress on this front – potentially including an announced formal clinical study or partnership with an authorized Kymriah or Yescarta center, could be a value inflection event, in our opinion.
European Approval for Treatment of Liver Disease and Trauma
Organ failure has recently become a significant focus for CTSO and new indications are directly aligned with that goal. In May 2018 CTSO announced CytoSorb received European approval for use in the reduction from the blood of elevated bilirubin and myoglobin. Elevated bilirubin is associated with chronic liver disease and failure, while elevated myoglobin, which is a symptom of severe trauma, can lead to kidney failure. While CE Mark has always meant that (at least in theory) clinicians (in areas of the world where CE Mark is accepted) had wide discretion to use CytoSorb as they saw fit (mostly for conditions in which cytokines are elevated), we think that this recent approval likely does expand the overall market for the device.
Bilirubin is a by-product from the breakdown of hemoglobin. Normally, bilirubin is conjugated (i.e. processed) by the liver and then excreted. But, in people with liver disease, the liver has difficulty processing bilirubin, resulting in a toxic build-up of the substance. Elevated bilirubin is common among people with hepatitis A, alcoholism and non-alcoholic fatty liver disease (NASH) - a global market estimated at approximately 50M people.
Myoglobin, found in heart and skeletal muscles, is tasked with capturing oxygen which muscles then use for energy. But, when the body experiences trauma, myoglobin (and other substances) is released into the blood and can become elevated (i.e. rhabdomyolysis). High levels of myoglobin can be toxic - it is the kidney's job to remove it from the blood so it can be excreted in the urine. Typical treatment consists of intravenous fluids and extracorporeal therapy (i.e. dialysis). As a reminder, CytoSorb was evaluated in a clinical study funded by a grant from the U.S. military for the removal of myoglobin in patients with rhabdomyolysis. It has also been the subject of case studies for rhabdomyolysis.
These new indications mean that clinicians can use CytoSorb on-label for conditions associated with elevated cytokines, myoglobin and bilirubin. 'On-label' potentially opens up use in instances where institutional policies forbid off-label use and, per management's comments on the call, may provide reimbursement benefits. And while not mentioned specifically by CTSO, we think that having approval may also open the door to one or more commercialization partnerships focused on these indications (perhaps similar to CTSO's deal with Fresenius).
CytoSorbents believes these new indications have the potential to significantly increase the total worldwide market for their device - while we think it is too early to estimate the significance of these approvals, we think they likely do broaden the market for CytoSorb (for the reasons stated) and, perhaps more importantly, provide additional strategic options. We also think it may be a harbinger of more approvals to come - clearly CTSO has already parlayed validation from grant-funded studies into broadening the commercial market for CytoSorb - that may be a strategy that they continue to employ.
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