Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2010, for Bacterin International Holdings, Inc. (formerly K-Kitz, Inc.). On June 30, 2010, the Company completed a reverse merger with Bacterin International, Inc., transitioning its business focus to biomaterials research, development, and commercialization. The Company develops biologics products (human allografts) and medical device coatings for orthopedic and other surgical applications. It is classified as a smaller reporting company.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2010 | Nine Months Ended Sep 30, 2010 |
|---|---|---|
| Total Revenue | $4,191,986 | $10,129,519 |
| Gross Profit | $3,480,813 | $8,296,552 |
| Gross Margin | 83% | 82% |
| Net Loss | $(9,043,227) | $(12,735,348) |
| Net Loss Per Share (Basic) | $(0.26) | $(0.42) |
| Cash and Cash Equivalents | $571,844 | $571,844 (Balance Sheet) |
| Total Current Liabilities | $13,194,392 | $13,194,392 (Balance Sheet) |
| Warrant Derivative Liability | $7,429,968 | $7,429,968 (Balance Sheet) |
Liquidity and Debt: The Company holds $571,844 in cash and cash equivalents. Total debt obligations include approximately $400,000 in convertible notes, $956,978 in notes payable, and $1,390,325 in long-term debt (including current portions). The Company raised approximately $9.27 million in June and July 2010 via private placement and debt conversion.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 203% for the quarter and 95% for the nine-month period compared to the prior year. This growth is attributed to the transition from a distributor model to a direct sales force model implemented in late 2009.
- Operating Expenses: Total operating expenses surged 159% for the quarter and 124% for the nine-month period. Significant increases were driven by sales and marketing costs (up 533% for the quarter) due to the expansion of the direct sales force, and stock-based compensation (up 565% for the quarter).
- Non-Cash Charges: The Net Loss was significantly impacted by a non-cash charge of $6,731,857 for the quarter (and $6,826,533 for the nine months) related to the change in fair value of warrant derivative liabilities issued during recent financings.
- Gross Margin Improvement: Gross margin improved to 83% for the quarter from 30% in the prior year, largely due to a $669,000 inventory adjustment recorded in Q3 2009 that inflated prior-year costs.
Guidance, Outlook, and Risks
Management Commentary: Management believes current cash resources, accounts receivable credit facilities, and recent financing will meet anticipated cash requirements through March 31, 2011. If revenue objectives are not met, the Company may need to sell additional equity (causing dilution) or seek loans.
Risks and Contingencies:
- Derivative Liability Volatility: The Company faces significant non-cash charges based on the fair value of warrants, which fluctuates with the stock price.
- Liquidity: The Company has a history of net losses and relies on external financing. Failure to raise additional funds could limit business expansion.
- Customer Concentration: Approximately 97% of sales are in the United States. One customer accounted for 9% of revenue in the nine months ended September 30, 2010.
- Internal Controls: While the Company states it has remedied prior internal control deficiencies following the reverse merger, it notes inherent limitations in all control systems.
Investor Verification Checklist
- Warrant Liability Impact: Verify the valuation methodology for the $7.4 million warrant derivative liability and its sensitivity to stock price changes.
- Sustainability of Gross Margins: Confirm if the 83% gross margin is sustainable or if it was artificially inflated by the reversal of prior inventory adjustments.
- Cash Burn Rate: Assess the runway provided by the $571,844 cash balance against the $5.9 million net cash used in operating activities for the nine-month period.
- Debt Covenants: Review the terms of the $400,000 convertible notes and other debt instruments for restrictive covenants that could be triggered by future losses.
- Direct Sales Efficiency: Evaluate the return on investment for the expanded direct sales force, given that sales and marketing expenses now represent 54% of revenue.