Business Context and Reporting Period
Registrant: Bacterin International Holdings, Inc. (now identified in the request as Xtant Medical Holdings, Inc.). The company develops, manufactures and markets human allograft biologics and antimicrobial medical-device coatings. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, compared with the corresponding 2011 periods.
Financial Results and Key Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Total revenue | $8.88 million | $7.54 million | $24.86 million | $21.05 million |
| Gross profit | $6.28 million | $6.22 million | $18.07 million | $17.00 million |
| Gross margin | 70.7% | 82.5% | 72.7% | 80.8% |
| Operating income (loss) | $0.21 million | $(1.57) million | $(1.41) million | $(3.78) million |
| Operating margin | 2.4% | (20.8)% | (5.7)% | (18.0)% |
| Net income (loss) | $(2.52) million | $(3.16) million | $(2.84) million | $1.35 million |
| Basic EPS | $(0.06) | $(0.08) | $(0.07) | $0.04 |
- Tissue sales were $8.64 million in Q3 and $24.43 million for nine months. Royalties and other revenue were less than 1% of nine-month revenue.
- Operating expenses declined 22% in Q3 and 6% for nine months, primarily because of lower sales and marketing costs and lower non-cash consulting expense. General and administrative costs increased.
- The nine-month net loss included a $1.39 million non-cash gain from remeasurement of the warrant derivative liability. The comparable 2011 period included a $7.47 million gain, contributing to the prior-year net income.
- Cash and cash equivalents were $8.62 million at September 30, 2012, compared with $0.75 million at December 31, 2011. Trade receivables were $7.18 million, and total current assets were $29.84 million.
- Cash used in operating activities was $7.81 million for the first nine months of 2012, compared with $6.42 million in 2011. Inventory increased by $5.09 million during the period.
- Cash used in investing activities was $1.22 million, primarily for property and equipment. Financing activities provided $16.89 million, principally from new debt and equity issuance.
- Total debt before debt discount was $21.43 million at September 30, 2012. Long-term debt, net of current maturities and discount, was $14.22 million. The company also reported $7.39 million of royalty liabilities related to the new financing.
- Total liabilities were $29.86 million and stockholders’ equity was $8.59 million at September 30, 2012.
Material Changes Versus the Prior Comparable Period
- Revenue increased 18% in both Q3 and the first nine months, attributed primarily to growth from the direct sales force and independent distributors as the company shifted from a distributor-only model to a hybrid model.
- Cost of sales increased 97% in Q3 and 68% for nine months. Cost of sales as a percentage of tissue revenue rose to approximately 29% in Q3 from 17% and to 27% for nine months from 19%, materially reducing gross margins.
- Q3 operating results improved from a $1.57 million loss to $0.21 million of operating income, but higher interest expense and other expense produced a $2.52 million net loss.
- Interest expense increased to $0.87 million in Q3 and $1.28 million for nine months, reflecting the higher balance and interest rate associated with the new ROS financing.
- In August 2012, the company entered into a $20 million term loan with ROS Acquisition Offshore LP, used to repay approximately $9.3 million of prior MidCap and Silicon Valley Bank facilities. The new loan bears interest at LIBOR plus 12.13%, subject to a 1% floor, and is secured by substantially all assets.
- The company issued 1,475,037 shares to Lincoln Park Capital for approximately $3.90 million during the first quarter and terminated that purchase agreement in May 2012.
- Cash was strengthened by financing, but operating cash consumption and inventory investment increased. Total inventory rose to $14.49 million from $9.40 million at year-end 2011.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management stated that cash and accounts receivable of approximately $15.8 million, together with anticipated operating receipts, were expected to meet cash requirements through September 30, 2013. Management also indicated that additional equity or debt financing could be required if revenue objectives are not met.
- Management expected approximately $16 million of sales and marketing expense for 2012 and estimated $4 million to $5 million of facility expansion or modernization spending over the following five years.
- The company faces substantial financing risk from the high-cost ROS facility, royalty obligations tied to net sales, debt covenants, and potential future capital requirements.
- Key operating risks include product acceptance, reimbursement and coverage changes, competition, regulatory requirements, availability of donor tissue, product liability, recalls, intellectual-property disputes, dependence on qualified personnel, and the ability to expand and manage the sales force.
- Disclosure controls and internal control over financial reporting were deemed ineffective because material weaknesses had not been fully remediated. Issues included inventory-system controls, insufficient accounting personnel and technical expertise, and inadequate documentation of equity transactions.
- Pending legal matters included a claim to recover approximately $1.65 million from SeaArk Capital for products delivered in 2011 and litigation involving a former regional vice president, including the former employee’s counterclaim. Other trademark and shareholder-related matters had been settled.
- The company had related-party relationships involving donor-tissue suppliers and waived certain conduct-code provisions to permit an entity controlled by the CEO’s adult children to become a distributor.
- Unusual non-cash items included the warrant derivative liability remeasurement gain, a $358,426 reduction in acquisition contingent consideration, non-cash consulting and stock-based compensation, and $1.74 million of Q3 other expense associated primarily with prepayment penalties and the write-off of debt issuance costs.
Important Facts for Investors to Verify
- Reconcile the filing’s cash-flow figures: the consolidated cash-flow statement reports $7.81 million of operating cash used, while the MD&A narrative cites $7.95 million.
- Assess whether the sharp increase in inventory can be converted into sales without additional reserves, working-capital pressure or margin deterioration.
- Review the terms, covenants, effective cost and royalty economics of the ROS financing, including the $7.34 million debt discount and royalty liability.
- Evaluate the company’s ability to fund ongoing operating losses and capital needs without further dilutive equity issuance or additional borrowing.
- Monitor remediation of the disclosed material weaknesses in financial reporting controls.
- Review customer concentration, receivable collectability and the pending SeaArk claim, including the company’s ability to recover the approximately $1.65 million sought.