Xtant Medical Holdings, Inc. — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, filed November 10, 2016. Xtant develops, manufactures and markets orthopedic and neurological products, including orthobiologics, tissue grafts, spinal implants and surgical instrumentation. Results include the X-spine Systems acquisition, completed July 31, 2015; therefore, prior-year comparisons are not fully comparable because 2015 includes X-spine only from the acquisition date.
Financial performance and key metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenue | $23.1 million | $17.7 million | $65.5 million | $37.1 million |
| Revenue growth | 30.5% | — | 76.7% | — |
| Gross profit | $16.0 million | $11.7 million | $44.8 million | $24.2 million |
| Gross margin | 69.2% | 65.9% | 68.3% | 65.2% |
| Loss from operations | $(1.9) million | $(4.9) million | $(6.4) million | $(8.0) million |
| Net loss | $(4.9) million | $(6.7) million | $(15.0) million | $(13.8) million |
| Net loss per share | $(0.40) | $(0.64) | $(1.24) | $(1.70) |
Orthopedic product sales were $22.9 million in Q3 and $65.0 million for the first nine months. Approximately 95% of nine-month revenue was generated in the United States. No customer represented more than 10% of revenue or accounts receivable.
Q3 gross margin improved to 69.2% from 65.9%, and nine-month gross margin increased to 68.3% from 65.2%, primarily due to product and customer mix and economies of scale associated with X-spine. Operating expenses were $17.9 million in Q3 and $51.2 million for the first nine months. Sales and marketing expense was $11.2 million in Q3 and $32.1 million year to date, representing approximately 48.7% and 49.0% of revenue, respectively.
Interest expense increased to $3.2 million in Q3 and $9.0 million for the first nine months, reflecting the debt used to finance the X-spine acquisition. The company also recognized non-cash gains from changes in the warrant derivative liability of $0.2 million in Q3 and $0.7 million year to date.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $1.4 million at September 30, 2016, down from $6.4 million at December 31, 2015.
- Cash and accounts receivable totaled $17.2 million at September 30, 2016.
- Cash used in operating activities was $11.2 million for the first nine months, compared with $9.0 million in the prior-year period.
- Cash used in investing activities was $5.6 million, primarily for property, equipment, surgical trays and clean-room facilities.
- Financing activities provided $11.8 million, including $8.4 million from the revolving line of credit, $2.2 million from convertible debt and $1.0 million from long-term debt.
- Total gross long-term debt was $120.1 million, consisting primarily of $70.2 million of 6% convertible senior unsecured notes due 2021, $43.0 million owed to ROS Acquisition Offshore and $6.9 million of PIK interest. Reported long-term debt, net of issuance costs, was $118.4 million, excluding the current revolving balance.
- The revolving credit facility was amended to provide up to $11.0 million and carried borrowings of $8.4 million at September 30, 2016.
- Stockholders’ equity declined to a deficit of $5.1 million from positive equity of $8.9 million at December 31, 2015, primarily reflecting the year-to-date net loss.
Material changes versus the prior comparable period
- Revenue increased substantially, primarily because of the X-spine acquisition and related product sales.
- Gross margin improved, while operating losses narrowed despite higher selling, marketing, research and development, and integration costs.
- Year-to-date net loss increased to $15.0 million from $13.8 million, principally because interest expense rose by $4.0 million and operating expenses increased.
- Sales and marketing expense increased 76.7% year over year for the first nine months, broadly in line with revenue growth.
- Inventory increased to $27.8 million from $24.3 million, while the inventory obsolescence reserve increased to $4.1 million from $3.6 million.
- Intangible assets declined to $37.0 million from $40.2 million after $3.4 million of accumulated amortization during the period.
- The company issued 150,000 shares to Aspire Capital for $0.3 million during the first nine months of 2016.
Outlook, risks, contingencies and unusual items
Management stated that available cash, accounts receivable, anticipated operating receipts, the Aspire Capital facility and the revolving credit line were expected to fund requirements through September 30, 2017. Management also stated that failure to meet revenue objectives could require additional equity or debt financing, potentially causing dilution, increased debt service and restrictive covenants.
The credit facility contains revenue, liquidity and leverage covenants. Amendments during 2016 reduced minimum liquidity requirements through January 1, 2017, permitted additional borrowing, increased the fee on amounts paid from 7.5% to 9.0%, and allowed interest to accrue as PIK interest during the third quarter. The company recorded $6.9 million of PIK interest at September 30, 2016.
The company expected relatively few additional X-spine integration expenses in the fourth quarter of 2016. A prior employment-related lawsuit was settled in the quarter ended March 31, 2016; the company remains subject to ordinary-course litigation, including product liability disputes.
After quarter-end, the company appointed a new president and granted him an option for 300,000 shares. It also launched a rights offering initially priced at $0.90 per unit and subsequently reduced to $0.75. If fully subscribed at $0.75, estimated gross proceeds were approximately $11.3 million and net proceeds approximately $10.2 million, excluding warrant exercise proceeds. These are post-period estimates, not proceeds included in the September 30 financial statements.
Principal risks include continued operating losses and negative equity, substantial leverage and interest obligations, compliance with credit-facility covenants, liquidity and financing availability, integration of X-spine, competitive and technological pressures, reimbursement and regulatory changes, product liability, intellectual-property matters, dependence on tissue donors, and the ability to retain personnel and maintain required accreditations.
Investor verification points
- Verify the company’s ability to satisfy revenue, liquidity and leverage covenants under the amended ROS facility.
- Assess whether operating cash burn and the $1.4 million cash balance are consistent with management’s stated funding horizon.
- Review the terms, actual proceeds and dilution from the post-quarter-end rights offering and associated warrants.
- Separate recurring operating performance from acquisition-related expenses, amortization, PIK interest and non-cash warrant gains.
- Monitor inventory growth, obsolescence reserves and accounts-receivable collectability.
- Evaluate the maturity, conversion and potential dilution terms of the $70.2 million convertible notes and the scheduled 2020 debt maturity.
- Confirm the status and financial impact of remaining X-spine integration activities, litigation and related-party purchases from Norwood Medical.