Xtant Medical Holdings, Inc. quarterly report, Q3 FY2015

Xtant Medical Holdings, Inc. — Form 10-Q Summary

Business context and reporting period

This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015. Xtant develops, manufactures and markets regenerative orthopedic products, tissue grafts, spinal implants and instrumentation. On July 31, 2015, the company acquired X-spine Systems, Inc., expanded into spinal medical devices, and changed its name from Bacterin International Holdings, Inc. to Xtant Medical Holdings, Inc.

Financial performance and position

Metric	Three months ended September 30, 2015	Three months ended September 30, 2014	Nine months ended September 30, 2015	Nine months ended September 30, 2014
Total revenue	$17.7 million	$8.5 million	$37.1 million	$26.3 million
Gross profit	$11.7 million	$5.4 million	$24.2 million	$16.5 million
Gross margin	65.9%	64.3%	65.3%	63.0%
Loss from operations	$(4.9) million	$(1.3) million	$(8.0) million	$(3.8) million
Operating margin	(27.6%)	(14.8%)	(21.6%)	(14.4%)
Net loss	$(6.7) million	$(1.2) million	$(13.8) million	$(7.2) million
Net loss per share	$(0.64)	$(0.19)	$(1.70)	$(1.26)

Third-quarter revenue increased 109.3%, and nine-month revenue increased 41.3%. The company attributed growth to the X-spine acquisition, increased sales headcount and improved sales-force productivity.
Cost of sales improved to 34.1% of revenue in the quarter from 35.7% and to 34.7% for the nine months from 37.0%, reflecting manufacturing efficiencies, product and customer mix, and the acquisition.
Operating expenses rose substantially, including sales and marketing expense of $8.4 million in the quarter and $18.2 million year to date, acquisition and integration expense of $3.9 million, and higher depreciation and amortization from acquired intangible assets.
Interest expense increased to $2.1 million in the quarter and $4.9 million year to date because of the new debt used to finance the acquisition.
Cash and cash equivalents were $8.0 million at September 30, 2015, compared with $4.5 million at December 31, 2014. Trade accounts receivable were $13.3 million and inventories were $23.7 million, including current and non-current inventories.
Total assets increased to $126.2 million from $28.0 million, primarily because of the X-spine acquisition. Goodwill was $24.0 million and net intangible assets were $42.2 million at quarter-end.
Total liabilities were $129.1 million, resulting in stockholders’ deficit of $2.8 million. Common shares outstanding increased to approximately 11.9 million from 6.7 million at December 31, 2014, principally due to shares issued in the acquisition.

Cash flow, debt and liquidity

Operating cash flow was negative $9.0 million for the first nine months of 2015, compared with negative $5.2 million in the prior-year period.
Investing cash flow was negative $73.4 million, primarily reflecting $73.0 million paid for the X-spine acquisition.
Financing cash flow was positive $85.8 million, including proceeds from $68.0 million of convertible senior notes, $18.0 million of additional borrowings under the amended ROS credit facility, and equity issuances.
Debt at September 30, 2015 included $68.0 million of 6% convertible senior notes due 2021, $42.0 million owed under the ROS facility, approximately $1.1 million of PIK interest, and $1.3 million of Valley Bank debt. Reported debt principal totaled approximately $112.4 million, before the small current portion and other presentation adjustments.
The ROS facility matures in 2020, bears significant cash and payment-in-kind interest, is secured by substantially all company and subsidiary assets, and includes minimum revenue, liquidity and leverage covenants.
Management stated that cash on hand, accounts receivable, expected operating receipts and potential Aspire Capital proceeds should satisfy anticipated cash requirements through December 31, 2016. The filing’s MD&A cites liquidity of $21.8 million from cash and accounts receivable, while the balance-sheet amounts sum to approximately $21.3 million; this difference should be reconciled.

Material changes versus the prior comparable period

The X-spine acquisition added a spinal-device business, approximately $88.0 million of preliminary purchase consideration, $24.0 million of goodwill and significant identifiable intangible assets. X-spine contributed approximately $91,000 of net profit after the July 31 acquisition date.
Revenue growth was accompanied by significantly higher operating expenses, interest expense and acquisition-related costs, resulting in materially larger operating and net losses.
The company recorded $3.9 million of acquisition and integration expenses, a $2.3 million gain from extinguishment of debt, and a $233,748 asset impairment charge during the nine months.
Warrant derivative liability was $1.4 million at September 30, 2015. The company recorded a $397,366 third-quarter gain but a $78,923 loss for the nine-month period from changes in fair value.
Inventory increased to $23.7 million from $11.5 million at year-end 2014, while the allowance for inventory obsolescence increased for current inventory.
The company discontinued or sold legacy Device Coatings and cranial maxillofacial fixation activities; those product lines each represented less than 1% of revenue.

Guidance, outlook, commentary and risks

No formal revenue or earnings guidance is provided. Management expects additional integration expenses in the fourth quarter of 2015 and first quarter of 2016.
Management expects the acquisition to expand product offerings and markets, increase sales coverage, enable cross-selling and produce operating efficiencies, but the filing cautions that these benefits may not materialize.
Key risks include continued operating losses and negative operating cash flow, substantial debt service, high interest rates and PIK accruals, credit-facility covenant compliance, refinancing needs and potential shareholder dilution.
Integration of X-spine, retention of its management and employees, dependence on a key distributor, and reliance on Norwood Medical, a related-party supplier, are significant acquisition-related risks.
The business depends on donor tissue availability, reimbursement and pricing, regulatory clearances, FDA and tissue-processing compliance, AATB accreditation, product quality, intellectual-property protection and avoidance of product-liability claims.
The company disclosed no material litigation beyond previously disclosed matters and ordinary routine litigation, including product-liability disputes. It also referenced a prior government subpoena concerning possible improper Medicare claims, while noting that the related qui tam action was dismissed without prejudice after the Department of Justice declined to intervene.
Subsequent events included a sale-leaseback of the Belgrade property on October 23, 2015 and commencement of trading on NYSE MKT under the symbol XTNT on October 19, 2015.

Most important facts for investors to verify

Whether X-spine integration produces the anticipated revenue growth, cost synergies and cash flow, and the final purchase-price allocation.
Compliance with ROS facility minimum revenue, liquidity and leverage covenants, including the consequences of any default or acceleration.
The company’s ability to fund ongoing operating losses and debt service without additional dilutive equity or expensive financing.
The reconciliation of the MD&A liquidity figure of $21.8 million to the balance-sheet cash and receivables totaling approximately $21.3 million.
Inventory utilization, receivable collections and the adequacy of reserves for doubtful accounts, obsolescence and impairment.
The effect of convertible-note conversion terms, warrants and additional equity issuances on future share-count dilution.
Regulatory, reimbursement, donor-supply, supplier-concentration, product-liability and healthcare-compliance developments.