Xtant Medical Holdings, Inc. annual report, FY2012

Business Context and Reporting Period

The filing is Bacterin International Holdings, Inc.’s Form 10-K for the fiscal year ended December 31, 2012, filed March 27, 2013. The request identifies Xtant Medical Holdings, Inc.; however, the filing itself identifies the registrant as Bacterin International Holdings, Inc., the predecessor name associated with the business.

The company develops, manufactures and markets human tissue-based biologics, orthopedic allografts, medical devices, surgical drains, bioactive coatings and related instruments. Revenue is generated primarily from tissue sales, with royalties and other revenue contributing less than 2% of total revenue.

Financial Performance and Key Metrics

Metric	2012	2011	Change
Total revenue	$32.98 million	$30.15 million	Up 9%
Gross profit	$22.64 million	$21.04 million	Up 8%
Gross margin	68.66%	69.79%	Down 1.13 percentage points
Operating loss	$(4.94) million	$(6.45) million	Improved $1.51 million
Net loss	$(7.71) million	$(3.01) million	Worsened $4.71 million
Basic loss per share	$(0.18)	$(0.08)	Worsened
Cash flow from operations	$(10.79) million	$(7.36) million	Higher cash use
Capital expenditures	$1.84 million	$1.02 million	Higher investment

Tissue sales were $32.41 million, or 98.28% of revenue. Royalties and other revenue were $565,873.
Cost of tissue and medical device sales increased 13% to $10.34 million, largely reflecting higher production costs and expanded capacity.
Operating expenses were $27.59 million, broadly unchanged from 2011. General and administrative expense increased 61% to $11.14 million, while sales and marketing expense declined 16% to $15.62 million.
Interest expense increased to $1.86 million from $1.16 million because of higher average debt and the 2012 financing.
The company recorded a $1.36 million non-cash gain from the change in warrant derivative liability, compared with a $6.38 million gain in 2011. It also recorded approximately $706,000 of debt-cost write-offs and approximately $944,000 of prepayment penalties associated with refinancing.
At December 31, 2012, cash and cash equivalents were $4.93 million, trade receivables were $7.15 million, and total current assets were $25.57 million. Management reported cash and accounts receivable of $12.08 million.
Inventories increased to $14.38 million from $9.40 million, including $13.14 million of current inventory and a $1.12 million obsolescence reserve.
Total assets were $34.50 million, total liabilities were $30.26 million, and stockholders’ equity was $4.23 million.

Material Changes Versus the Prior Comparable Period

Revenue increased 9%, driven primarily by the direct sales force and independent distributors as the company transitioned from a distributor-only model to a hybrid distribution model.
Gross margin declined modestly because production-capacity expansion increased product costs.
Operating loss improved despite higher general and administrative costs, mainly because sales and marketing expense and non-cash consulting expense declined.
Net loss increased substantially because the prior year included a much larger favorable change in warrant derivative liability and 2012 included higher interest expense and refinancing-related charges.
Operating cash outflow increased by $3.43 million, primarily due to the net loss and a $4.98 million increase in inventory.
Debt was refinanced in August 2012. The prior MidCap and Silicon Valley Bank facilities were repaid with proceeds from a new ROS Acquisition Offshore LP facility.
Shares outstanding increased to 42.88 million at year-end from 40.84 million, including approximately $3.88 million raised through the issuance of common stock to Lincoln Park Capital.

Debt, Liquidity and Financing

The August 2012 ROS facility provided an initial $20 million term loan, with potential for an additional $5 million subject to revenue objectives through December 31, 2013.
The ROS loan bears interest at LIBOR plus 12.13%, subject to a 1% LIBOR floor, and is secured by substantially all company assets.
The financing also requires royalties of 1.75% on the first $45 million of net sales and 1% on net sales above $45 million for ten years. Estimated future royalty payments totaled approximately $13.84 million.
Debt principal before debt discount was $21.42 million at year-end, consisting primarily of the ROS loan and a Valley Bank building loan. Long-term debt, net of current portion and discount, was $14.48 million.
Management stated that cash, accounts receivable and anticipated operating receipts were expected to fund requirements through December 31, 2013. The company expected 2013 sales and marketing expense of approximately $18 million and anticipated $4 million to $5 million of facility investment over five years.
Management warned that failure to meet revenue objectives could require additional equity or debt financing, potentially causing dilution or increasing debt-service obligations.

Guidance, Outlook, Risks and Unusual Items

No formal revenue or earnings guidance was provided. Management expected sales and marketing expense of approximately $18 million in 2013 and projected facility investment of $4 million to $5 million over the following five years.
The company received two FDA warning letters on January 29, 2013 concerning quality-system, complaint-handling, corrective-action, training, reporting, product-control and marketing-material procedures, including materials related to the Elutia wound drain.
On February 11, 2013, the Department of Health and Human Services Office of Inspector General issued a subpoena relating to a possible investigation of improper Medicare claims involving a physician referral and education program discontinued in 2010. The company stated that it intended to cooperate.
Management disclosed material weaknesses in internal control over financial reporting: insufficient accounting personnel and expertise for account reconciliations and financial close activities, and inadequate documentation of equity transactions. Disclosure controls were therefore deemed ineffective as of December 31, 2012.
The company is exposed to substantial regulatory, product-liability, recall, reimbursement, pricing, donor-tissue availability, competition, intellectual-property and facility-concentration risks.
The company faced potential NYSE MKT continued-listing risk because its stock price was below $1, it was operating at a loss, and market capitalization, assets and revenue were below $50 million.
Pending litigation included a claim seeking approximately $1.65 million from SeaArk for products delivered in 2011. A separate dispute with a former regional vice president was settled in January 2013, with the former employee agreeing to pay $15,000 and not compete or solicit customers for one year.
Related-party arrangements included tissue procurement transactions with entities associated with directors or management and an affiliated distributor owned by the CEO’s adult children. Accounts payable to American Donor Services was $418,922 at year-end.

Most Important Facts to Verify

Confirm the registrant’s corporate identity and relationship to Xtant Medical Holdings, Inc., because the filing is under Bacterin International Holdings, Inc.
Review the ROS credit and royalty agreements, including the high interest rate, collateral package, revenue-based borrowing conditions and required sales royalties.
Assess whether operating cash flow, inventory growth and planned capital expenditures were consistent with the stated liquidity through 2013.
Track remediation of the disclosed material weaknesses and any subsequent restatements or control deficiencies.
Monitor the FDA warning-letter response, remediation requirements and any effect on product sales or regulatory approvals.
Monitor the OIG subpoena and any resulting investigation, claims, penalties or reimbursement exposure.
Evaluate potential dilution from outstanding options, warrants, restricted stock and future financing needs.
Assess compliance with NYSE MKT continued-listing requirements and any subsequent listing-status actions.