Business Context and Reporting Period
Xtant Medical Holdings, Inc. was named Bacterin International Holdings, Inc. during the period covered by this filing. The unaudited Form 10-Q covers the three and six months ended June 30, 2012, with comparative periods ended June 30, 2011.
The company develops, manufactures and markets biologics, human allografts and antimicrobial medical-device coatings. Its biologics products support spine, orthopedic, foot and ankle, neurosurgical and cartilage-related procedures. Although it had biologics and devices divisions, devices revenue was immaterial and the company reported one operating segment.
Financial Performance and Position
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Six months ended June 30, 2012 | Six months ended June 30, 2011 |
|---|---|---|---|---|
| Total revenue | $8.21 million | $7.51 million | $15.98 million | $13.51 million |
| Gross profit | $5.88 million | $5.77 million | $11.79 million | $10.78 million |
| Gross margin | 71.6% | 76.8% | 73.8% | 79.8% |
| Operating loss | $(0.35) million | $(0.28) million | $(1.62) million | $(2.22) million |
| Net income (loss) | $0.73 million | $(0.41) million | $(0.32) million | $4.51 million |
| Net margin | 8.9% | (5.4)% | (2.0)% | 33.4% |
| Net cash used in operating activities | Not separately provided | Not separately provided | $(4.86) million | $(4.45) million |
- Six-month tissue sales were $15.78 million; royalties and other revenue were $0.19 million. Approximately 97% of first-half 2012 revenue was generated in the United States.
- At June 30, 2012, cash and cash equivalents were $1.21 million, trade accounts receivable were $6.58 million, and total current assets were $20.68 million.
- Total inventory was $13.34 million, up from $9.40 million at December 31, 2011. The increase was a significant use of operating cash.
- Total assets were $28.45 million and stockholders’ equity was $10.14 million at June 30, 2012.
- Gross debt was $10.76 million, including $4.26 million classified as current, plus capital lease obligations totaling approximately $0.28 million.
- The company had a $5 million accounts-receivable revolving facility available through January 2015, subject to borrowing-base limitations. It also had a $7 million term facility and a building loan.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue increased 9% year over year, while first-half revenue increased 18%, primarily from the hybrid direct-sales and independent-distributor model.
- Cost of sales increased faster than revenue: 34% in the second quarter and 53% in the first half. Gross margin declined by approximately 5.2 percentage points in the quarter and 6.0 percentage points year to date, reflecting higher production overhead allocation and other manufacturing costs.
- Second-quarter general and administrative expense increased 54% to $2.32 million, while sales and marketing expense declined 11% to $3.84 million. First-half general and administrative expense increased 26%, while sales and marketing expense declined 7%.
- The second-quarter loss from operations widened to $0.35 million despite higher revenue. The first-half operating loss improved from $2.22 million to $1.62 million.
- Net income in the second quarter benefited from a $1.30 million non-cash gain from the change in the warrant derivative liability. The first half benefited from a $1.52 million gain. The comparable first-half 2011 net income included a much larger $7.23 million warrant-related gain, making year-over-year net income comparisons less representative.
- Operating cash use increased to $4.86 million from $4.45 million. Financing activities provided $6.20 million, including $3.90 million from issuing 1.48 million shares to Lincoln Park Capital and $2.74 million of revolving debt borrowings.
- Shares issued and outstanding increased to 42.75 million at June 30, 2012 from 40.84 million at December 31, 2011. The Lincoln Park purchase agreement was terminated on May 3, 2012.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management stated that cash, accounts receivable, availability under the receivables facility and anticipated operating receipts were expected to fund requirements through June 30, 2013. This assessment depends on achieving revenue objectives and maintaining financing access.
- Management expected approximately $20 million of sales and marketing expense in 2012, compared with approximately $19 million in 2011. These costs were expected to be largely variable and funded by operating cash flow.
- The company anticipated spending $4 million to $5 million over the next five years to expand or update facilities.
- Failure to meet revenue objectives could require additional equity or debt financing. Additional equity could dilute existing holders, while debt could increase service requirements and impose restrictive covenants.
- Principal risks include dependence on donor cadavers, product acceptance and reimbursement, competition, regulatory changes, product liability, recalls, intellectual property disputes, qualified personnel, customer concentration and the ability to scale operations.
- One customer represented 7% of first-half 2012 revenue and 21% of accounts receivable at June 30, 2012. Approximately 97% of first-half revenue was domestic.
- The company recorded Level 3 warrant derivative liabilities of $0.83 million and acquisition contingent consideration of $0.09 million at June 30, 2012. Both balances and related gains depend on valuation assumptions.
- The company settled the Yanaki and Activatek litigation confidentially on July 17, 2012. It was pursuing a $1.65 million receivables claim against SeaArk, had settled a trademark dispute requiring discontinuation of the SteriSponge mark, and had a pending trade-secret and related claims action against a former executive.
- Disclosure controls and internal control over financial reporting were reported ineffective because material weaknesses had not been fully remediated. The weaknesses involved inventory-system integration, accounting personnel and technical expertise, close-process controls, and documentation of equity transactions.
- A related-party payable to American Donor Services was $0.57 million. The company also granted a Code of Conduct waiver permitting an entity controlled by the CEO’s adult children to become a distributor.
Most Important Facts to Verify
- Whether the company can convert its elevated inventory balance into sales and operating cash flow without additional reserves or write-downs.
- The maturity schedule and refinancing requirements for approximately $10.76 million of debt, including $2.76 million due in the remainder of 2012 and $3.20 million due in 2013.
- Whether operating cash burn and planned sales and marketing spending are consistent with management’s liquidity assessment through June 30, 2013.
- The sustainability of reported profitability after excluding non-cash warrant-liability gains and other unusual items.
- Progress in remediating the disclosed material weaknesses in internal controls.
- The outcome and collectability of the $1.65 million SeaArk claim and any potential costs or recoveries from other litigation.
- The effect of equity issuance, outstanding options and approximately 6.97 million warrants on future dilution.
- The implications of the related-party supplier balance and the distributor relationship involving the CEO’s family members.