Xtant Medical Holdings, Inc. quarterly report, Q3 FY2014

Xtant Medical Holdings, Inc. (then Bacterin International Holdings, Inc.) — Form 10-Q Summary

Business context and reporting period

The filing covers the three and nine months ended September 30, 2014, and was filed November 7, 2014. At the time, the registrant operated under the name Bacterin International Holdings, Inc. The company developed, manufactured and marketed human allograft biologics, tissue products and bioactive medical-device coatings. The filing identified biologics and devices as separate business lines but reported one operating segment because device revenue was immaterial.

The interim financial statements are unaudited. Approximately 98% of nine-month revenue came from the United States. A 1-for-10 reverse stock split became effective for trading on July 28, 2014.

Financial performance and position

Metric	Three months ended September 30, 2014	Three months ended September 30, 2013	Nine months ended September 30, 2014	Nine months ended September 30, 2013
Total revenue	$8.45 million	$7.93 million	$26.25 million	$24.82 million
Gross profit	$5.44 million	$4.61 million	$16.53 million	$14.80 million
Gross margin	64.3%	58.2%	63.0%	59.7%
Operating loss	$(1.25) million	$(2.35) million	$(3.77) million	$(5.45) million
Net loss	$(1.17) million	$(4.38) million	$(7.21) million	$(8.53) million
Basic loss per share	$(0.19)	$(0.85)	$(1.26)	$(1.83)

Third-quarter revenue increased 6.6%, driven by higher sales volume. Nine-month revenue increased 5.8%, which management attributed to improved sales-force productivity following a restructuring.
Cost of sales declined to 35.7% of revenue in the third quarter and 37.0% for the first nine months, versus 41.8% and 40.3%, respectively, in the prior-year periods. Management cited fewer expired-inventory write-offs and improved processes.
Third-quarter operating expenses declined 3.9%, while nine-month operating expenses were broadly flat. General and administrative expense declined, but research and development expense increased substantially and nine-month sales and marketing expense rose 2.7%.
Interest expense increased to $1.50 million in the third quarter and $4.22 million for the first nine months, reflecting higher average debt balances.
A non-cash gain from the warrant derivative liability was $1.65 million in the third quarter and $1.04 million for the first nine months. The gain was primarily driven by a decline in the company’s stock price and materially reduced reported net losses.

Cash flow, debt and liquidity

Cash and cash equivalents were $6.95 million at September 30, 2014, compared with $3.05 million at December 31, 2013. Accounts receivable were $4.29 million, producing cash plus accounts receivable of approximately $11.25 million.
Operating activities used $5.17 million of cash during the first nine months, substantially consistent with $5.18 million used in the prior-year period. Investing activities used $0.18 million, primarily for property and equipment.
Financing activities provided $9.26 million, including $4.0 million of additional ROS debt and approximately $5.9 million of net proceeds from an August public offering.
Total debt obligations before debt discount were approximately $26.04 million at September 30, 2014, including a $24.0 million ROS loan, a $0.7 million adjustment fee payable to ROS and approximately $1.34 million owed to Valley Bank. The ROS loan bears interest at LIBOR plus 12.13%, subject to a 1.0% LIBOR floor, and matures in August 2019.
The ROS facility is secured by substantially all company assets and includes financial and operating covenants, minimum liquidity and revenue requirements, waiver fees and a royalty obligation. The company reported $7.38 million of estimated initial royalty liability, with total estimated future royalty payments of approximately $12.47 million as of September 30, 2014.
Stockholders’ deficit was $4.46 million at September 30, 2014, compared with a deficit of $3.84 million at December 31, 2013. Accumulated deficit increased to $67.57 million.

Material changes versus the prior comparable period

Revenue and gross profit improved, while gross margin expanded by approximately 6.1 percentage points in the third quarter and 3.3 percentage points for the first nine months.
Operating and net losses narrowed, but the company remained unprofitable and continued to consume cash from operations.
Research and development expense increased to $0.38 million in the quarter and $0.96 million year to date, partly because personnel costs were reclassified from general and administrative expense.
In March 2014, the company borrowed an additional $4.0 million from ROS and issued 150,000 shares to an ROS affiliate in connection with the credit agreement amendment.
In August 2014, the company issued 1.143 million shares at $5.70 per share and warrants to purchase 571,500 shares at $7.12 per share. Gross proceeds were approximately $6.5 million and net proceeds were approximately $5.9 million.
Common shares outstanding increased to 6.685 million at September 30, 2014 from 5.343 million at December 31, 2013, before considering subsequent changes. The offering and other equity issuances increased dilution risk.

Guidance, outlook, commentary and risks

Management expected 2014 sales and marketing expense of approximately $17 million, compared with approximately $16 million in 2013, with spending focused on the sales force. No specific revenue or earnings guidance was provided.
Management stated that cash on hand, accounts receivable and anticipated operating receipts were expected to fund requirements through September 30, 2015. However, it warned that additional equity or debt financing may be necessary if revenue objectives are not achieved or operating cash flow is insufficient.
The company was not in compliance with NYSE MKT continued-listing requirements and did not expect to regain compliance by the November 13, 2014 deadline. It stated that delisting proceedings were likely, creating substantial trading, financing and investor-access risk.
The company remained exposed to covenant breaches and potential acceleration of ROS debt. A default could result in loss of substantially all pledged assets, including intellectual property.
Reported profitability was affected by significant non-cash warrant-liability remeasurement gains. These gains may reverse with changes in the stock price and should not be treated as recurring operating performance.
Material contingencies included a former employee lawsuit seeking damages exceeding $5 million, an $80,000 fee and warrant claim by Middlebury Securities, and a $150,000 investment-banking fee claim by the Rodman & Renshaw bankruptcy trustee. The company disputed each claim.
The filing disclosed continuing regulatory risks, including a prior FDA Warning Letter and unresolved follow-up inspection matters involving the Belgrade, Montana facility and tissue-processing activities.
Other major risks included dependence on human tissue donors, reimbursement and pricing pressure, FDA and tissue-product compliance, product liability and recalls, competition, intellectual-property disputes, healthcare reform, financing availability and the company’s history of losses.

Most important facts for an investor to verify

Whether the company regained NYSE MKT compliance or proceeded toward delisting after November 13, 2014.
The current status, amendments, covenant compliance and potential acceleration provisions of the ROS credit facility.
Whether operating cash flow improved sufficiently to avoid additional financing and related dilution.
The ultimate resolution and potential financial exposure from the three disclosed legal claims.
The status of FDA follow-up inspections, the Warning Letter and any required corrective actions or enforcement.
The composition and valuation sensitivity of the $2.02 million warrant derivative liability and the effect of future stock-price movements on reported earnings.
Actual donor-tissue availability, inventory reserves and sales-force productivity relative to management’s growth expectations.