Xtant Medical Holdings Inc (XTNT) 2012 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Bacterin International Holdings, Inc. First Quarter 2012 Earnings Conference Call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for questions.

(Operator Instructions).

Today's conference is being recorded May 3, 2012. I would now like to turn the conference over to Guy Cook. Please go ahead.

Thank you, Lisa, and good afternoon, everyone. Thank you for joining us today to discuss our first quarter 2012 results. We issued a press release this afternoon announcing our earnings results.

Revenue for the quarter was $7.8 million, compared to $9.1 million in the previous quarter and an increase of 29% compared to $6.0 million in the first quarter of 2011. Excluding a $1.4 stocking order sale in the fourth quarter of 2011, revenues increased slightly from $7.7 million, $7.8 million on a sequential basis.

Although revenue was lower than anticipated, due largely to six of our top 10 product categories being on back order in January and February, we have substantially increased our available inventory in March and April as well as increasing our processing capabilities during the quarter, which we expect to have a positive impact on revenue in the third quarter of 2012 and from there on.

Inventory increased 21% by the end of the quarter, from $9.4 million in the fourth quarter of 2011 to $11.4 million. As of March 31, 2012, we had approximately $1.6 million of inventory of cost on consignment of hospital accounts, which translates to approximately $6.4 million of inventory at retail value.

Inventory is now readily available to our sales force, and by the end of the first quarter we had signed on an additional 140 facilities. We are optimizing our processing facility to meet the demand for our products, including hMatrix, which we believe will be positively impacted under new reimbursement codes.

Margins returned to north of the 70% to 75% range that we had guided for, to 76%. And at March 31, 2012, we had approximately $1.4 million in cash with immediate access to approximately $3.8 million on our non-dilutive revolving account receivable credit facility.

Before we go too much further, I'd like to turn the call over to our CFO, John Gandolfo, who will walk us through a summary of the quarter and year's financial results. When he's finished, I'll return to give a more detailed operational update and a look ahead. Then we'll open up the call to your questions. John?

Thank you, Guy, and thanks, everyone, for joining us today. Now, turning to our results for the first quarter of 2012. As Guy mentioned, revenue for the quarter was $7.8 million, compared to $9.1 million in the previous quarter, and an increase of 29% compared to $6 million in the first quarter of 2011. Excluding the $1.4 million stocking order sale in the fourth quarter of 2011, revenues increased slightly from $7.7 million to $7.8 million on a sequential basis.

The year-over-year increase was largely the result of increased sales generated from the Company's direct sales force and independent distributors compared to the first quarter of 2011. Gross profit margin for the quarter was 76%, as compared to 44% in the previous quarter and 84% in the year-ago quarter.

As Guy mentioned, our first quarter 2012 gross margin was above the previously given guidance of gross margins between 70% and 75%. The fourth quarter 2011 gross margin figure was negatively impacted by approximately $1.2 million of non-recurring charges as well as the lower gross margin on a $1.4 million stocking order sale, which was due to a larger volume price discount for that sale.

Operating expenses for the quarter totaled $7.2 million, as compared to $6.7 million in the previous quarter and $6.9 million in the first quarter of 2011. Operating loss for the quarter was $1.3 million, and this compared to $2.7 million loss in the previous quarter and a $1.9 million loss in the first quarter of 2011. Net loss was $1 million, or $0.03 per basic share for the quarter, and this compares to a net loss of $4.4 million, or $0.11 per basic share in the previous quarter, and net income in the first quarter of 2011 of $4.9 million, or $0.13 per basic share.

Our first quarter 2011 net income figure included a decrease in our non-cash warrant derivative liability of approximately $7.2 million, which was the reason for the income during that quarter. EBITDA for the quarter totaled a loss of $541,000, compared to an EBITDA loss of $1.5 million for the previous quarter and an EBITDA loss of $1.2 million for the first quarter of 2011. Please see the definition and an important discussion about the use of EBITDA, a non-GAAP term, in today's earnings release, which is available in the Investors section of our website.

Now, turning to the balance sheet, cash and cash equivalent and net accounts receivable was $9 million on March 31, 2012, and this compared to a total of $7.8 million at December 31, 2011. We also have immediate access to $3.8 million on our non-dilutive revolving AR credit facility, which we closed in April of this year.

This completes my summary report on our results. For a more detailed and complete analysis of our results for the first quarter of 2012, I'd like to direct everyone to our Form 10-K filed with the SEC in March 2012 as well as the Company's Form 10-Q, which will be filed later this week and which will be available at www.sec.gov and via our website. I'll be happy to answer any questions you have during the Q&A session.

Now, I'd like to turn the call over to Guy. Guy?

Thank you, John.

As our leading competitor continues to lose market share, we continue to see an increased number of requests for proposals from major institutions such as the Scripps Health Hospital System, which we recent gained access to, where our products may be used as alternatives, and we expect this to increase -- to continue as these contracts come up for renewal.

Our recently expanded direct sales force, now up to 70 people, is building its sales pipeline and we are in the process of hiring another 10 to 12 representatives by the beginning of the third quarter. We recently won our third GPO contract, a three-year agreement with a leading healthcare supply chain expertise and contracting company to provide OsteoSponge, OsteoSelect DBM Putty, and OsteoWrap or OsteoLock, or BacFast, hMatrix, or Sports Medicine Allografts and our Traditional Allografts to the GPO's nationwide network of hospitals and medical practices. Hospital accounts in the quarter increased to 756 facilities, an increase of 45% over the 509 facilities we had in Q1 of 2011.

We also secured an accounts receivable credit facility with Midcap Financial LLC and Silicon Valley Bank for up to $5 million through January 1, 2015 based upon a predetermined formula for borrowings of up to 80% of Bacterin's eligible accounts receivable, as defined in the credit and security agreement. With this additional working capital provided by this AR revolver, we will be terminating the Lincoln Park Capital equity line.

We are confident we have now overcome our short-term production issues; however, beginning the quarter with SKUs or product codes on back order and unavailable to convert new surgeons, this slows the surgeon uptake when the product does become available because it delays the start of the sales cycle.

Typically, surgeons who currently use the product continue to reorder. But to convert new surgeons, each new surgeon needs to be approached, use the product in one or two cases, and they will typically wait 60 to 90 days to see if they like the results before they begin ordering in greater volume. When product is constrained, it goes into back order and it delays the uptake in the growth we've historically experienced and gets pushed out by a few quarters.

We are confident in our long-term growth potential based upon our increased production and continued demand for our products. We were able to sign up 140 new accounts by the end of the quarter, continuing to build our pipeline, but building these new accounts into meaningful recurring sales will take longer than we originally anticipated.

hMatrix, with ease of implantation and fast revascularization rates, is gaining the attention of physicians in the treatment of breast reconstruction and diabetic foot ulcers. Uptake was slower than expected due to reimbursement issues surrounding diabetic foot ulcers, which we believe will be corrected with the expected issuance of the necessary Q code by mid-May, which will become effective January 1, 2013.

We also made improvements with respect to the product sizes of hMatrix that we expect to yield higher sales over the last three quarters of 2012. We continue to have excellent clinical results with our products with over 110,000 implants to date and no adverse events.

In April, a peer reviewed article in Orthopedic Research and Reviews determined OsteoSponge exhibits ideal properties for bone regeneration, similar to those of autografts, grafts of the patient's own bone, with the distinct advantage of our allografts being that there is no risk of complications at the harvest site or donor pain post operatively. We are very pleased to have this paper to share with surgeons, materials managers, and distributors that not only is OsteoSponge equal to, but offers attributes even better than the patient's own bone for graft procedures.

Also, recent studies conducted at the Hospital for Special Surgery have shown the OsteoSelect DBM Putty proved equivalent to antilogous bone graft in the posterolateral intertransverse rabbit model. This data will be used to gain additional indications for OsteoSelect DBM such as craniomaxillofacial and is expected to help drive sales in the remainder of 2012 and 2013. The OsteoSelect DBM Putty proved equivalent to antilogous bone graft, which is the current gold standard for spinal fusion.

While we have treated more than 200 patients with our OsteoSponge SC product, we expect independent data on OsteoSponge SC for treatment of subchondral defects before the end of the year. As positive clinical developments continue in this area, it represents an enormous opportunity for Bacterin shareholders.

As for quarterly guidance, because our industry sells product on a consignment basis, we have poor visibility on recordable revenues until one or two weeks after the close of the month, which makes it extremely difficult to provide quarterly revenue guidance.

Based upon production challenges in the fourth quarter of 2011, feedback from the field with respect to second quarter sales and surgeon uptake rates, our decision not to pursue stocking order sales of slow moving inventory, which represented approximately 10% to 15% of our 2012 sales in prior revenue guidance as well as delays in revenues generated from our hMatrix product, we feel it's prudent to revise guidance from our previously stated expectation of 2012 revenues of $53 million to $56 million down to $35 million to $40 million.

We have added a second production shift and later in the year we'll be expanding the number of clean rooms we develop for high demand products to a total of 13 for our plans to optimize processing for our high demand products and expect processing capacity to double from current levels by the end of the year.

In addition, we're also ramping up our donors from our current 40 to 45 per month up to 60 by the end of Q3 and eventually to 80 per month by the end of Q4, which would be necessary to eventually support $100 million of annual production of inventory.

We continue to believe the expansion of processing capacity is warranted due to the large addressable markets, demand from our current clients, and acquisition of new and larger accounts. There's a lag time of processing capacity, so it takes approximately two to nine months to clear a donor because of related documentation and laboratory testing results necessary to begin the processing. We believe that our Q1 product constraints are a short-term issue we have resolved and that the future and long-term opportunity for Bacterin products in multi-billion dollar addressable markets remains very strong.

Now, I think we're ready to open the call for your questions. Alicia, please provide the appropriate instructions.

Thank you. Ladies and gentlemen, at this time we will begin the question-and-answer session. (Operator Instructions). And our first question comes from the line of Matthew O'Brien with William Blair. Please go ahead.

Good afternoon. Thanks for taking the questions. I was hoping I could get, just from a housekeeping perspective, Osteo products, hMatrix, and medical supplies revenue in the quarter.

I'm not sure that we -- this is John speaking. I don't think that we have the breakdown available right here. I know I don't have it in front of me, but we could get back to you with that, certainly. I would think the Osteo products are probably 95% of the revenues, so compared to the other products.

Yes. I'll clarify. I think that OsteoSponge and Wrap will be approximately 65% to 70% of the sales, with approximately 15% to 20% of our DBM Putty being the balance. The hMatrix is still a relatively small percentage, probably 2% to 5%, this range. But we do expect hMatrix to be a significant contributor to the revenues in the balance of the year. We're still projecting approximately 5% to 10% of our revenues for both this year and next to be our hMatrix product.

Okay. And then, I was hoping you could help me reconcile the change in the outlook for the year. I understand that the production issue obviously didn't help in the quarter and you're talking about these distributors no longer -- or not selling to these distributors, some of these slower-moving products. I'm estimating that costs you about $3 million to $4 million this year.

You're taking guidance down by $18 million to $19 million and you only issued guidance or reiterated it about five to six weeks ago, so what is it that's changed here in such a dramatic fashion?

Well, first of all, the stocking orders to distributors represented about $7 million, and we just decided that we're not going to pursue those. So that's one major change in terms of the guidance. The balance is primarily due to the delays in terms of the reimbursement on the hMatrix, which is going to push back those revenues from those products as well as the production issues that we're in the process of resolving.

Okay. And then, can you just -- you talked about the inability to start new surgeons. What about your ability or your reorder rates among existing surgeons, maybe that have been using the product for six to 12 months? What does that look like and are you growing with those surgeons at this point?

Yes. We feel that those surgeons are buying at the somewhere reorder rates that have historically. We attribute the lack of 15% to 20% growth to the production constraint, now that even the surgeons that have used the product and are comfortable with it do not have that available to them in that January/February window.

Okay. And then, I was hoping you could give us a sense now for given that the production capabilities of the firm are so much better, are you still backlogged on those six key products?

We are not. And we exited the backorder situation probably mid-March and now we feel that we're in very good shape moving forward.

Okay. So just back to the first question, then, taking guidance down by $19 million-ish on the top-line, $7 million of that is the stocking, hMatrix is maybe a couple of million. That $10 million delta there, what exactly is that attributable to?

I think it goes back to when it follows our backorder it slows down the sales cycle and the uptake. We feel that it's going to take a while to gain some additional accounts we originally expected and that we're basically being pushed back by two quarters from what we originally anticipated.

Okay. And then, one more for me, John. Can you just, exiting March, give us a sense for what your -- well, I shouldn't say exiting March just given that you just did this revolver. But as it stands today, how much cash do you have available to fund the business going forward and how should we think about EBITDA now given the top-line reduction to guidance?

Yes. I think that in terms of the cash available with the $3.8 million immediately available from the revolver as well as the current cash, it's in excess of $5 million currently available to the Company, which is why we terminated or sent notice of termination with respect to that Lincoln Park Capital equity line. We think that that cash is sufficient to continue to execute the strategy.

At the top end of the guidance that we -- the revised guidance that we've just given, you're talking about generating positive EBITDA for the year, which is why we're comfortable in terminating that Lincoln Park equity line.

Okay, great. Thank you.

Thank you. Our next question comes from the line of Caroline Corner with MLV. Please go ahead.

Hi. This is Yumi in for Caroline. Thanks for taking my questions today. First of all, have you had any communications with the FDA regarding the coatings business?

Yes, we have. We've received 13 questions back. They are typical of what we have received back in prior submissions. We expect to be meeting with them within the next 30 days to respond to those questions. We continue to answer the questions and we, at this point, expect it to be similar to the other experiences that we've had with the FDA, where it's taking two to three series of questions and questions answered before we gain approval.

Okay, great. And also, regarding hMatrix, you mentioned breast reconstruction earlier, but are you expecting that both shoulder repair and breast reconstruction, that those will be the two kind of major indications for hMatrix, at least for right now?

Right now, we're gaining a lot stronger surgeon uptake in the breast reconstruction market. It's not subject to the reimbursement codes that we need to have in place for the diabetic foot ulcer market. So we think -- and we are optimizing our production processes and techniques for that particular market, and so we expect -- we think we'll have greater uptake in the next three quarters.

Okay, great. Thanks. That's it for me.

Thank you. Our next question comes from the line of Bruce Jackson with Northland Securities. Please go ahead. Mr. Jackson, your line is open if you have a question.

Thank you for taking my questions. First, with the sales people, can you tell us the number of reps and the sales managers [memo], the total sales force numbers?

Right now, we're at approximately 50 direct reps, Bruce. We have offers to 10 more that we'll be hiring in the next six weeks, in that timeframe. And then we have 15 -- actually, I take that back, we have 13 RVPs, regional VPs, and two EDTs and a national sales manager. We also have five people in our customer service force as well.

Okay, so that gets us over 70. Then, with the revenue that's direct versus distribution, what percentage of revenue went through distributors this quarter?

68% came from distributors, 32% from direct reps.

Okay. And then, did you mention a revenue number for the orthopedic implant business in the licensing?

No, I think it was immaterial in the quarter, Bruce. We didn't mention it.

Okay. Then, you anticipate getting a Q code in May for the hMatrix product and it's not actually going to go into effect until 2013 or --can you explain that (inaudible)?

Yes. The approval process takes place throughout the year before it's actually effective. So it will go effective January 1 of 2013.

Okay. And then, obviously you guys had some production issues during Q1. Now, as you're moving into April and May and you've got the backlog resolved, any commentary on how the current quarter is unfolding for you?

I'd say it's still too early to tell. I think the bar levels are as strong as they've ever been with the Company, with our most popular products. And I think we have definitely expected growth to occur, but I think it's too early to tell.

Okay. And do you have any thoughts on how the revenue might calendarize by quarter moving forward with the reduced gains? So, would you expect that revenue would be up sequentially in Q2 or about the same levels as in Q1? How do you think the revenue is going to build for the rest of the year?

As we mentioned, we expect the sales increase associated with the back order issue that has been alleviated to begin showing up on the revenue line in the third and fourth quarter. So I would expect a slight increase in sales in the second quarter; and then as you go to the third quarter, much higher growth rates on a sequential basis.

Okay. And with the coded orthopedic implants, are we still looking at a possible launch in the second half of the year? Is that your current thinking?

That's our current thinking at this time, yes.

Okay, that's it for me. Thank you.

Thanks, Bruce.

Thank you. Our next question comes from the line of Anthony Vendetti with Maxim Group. Please go ahead.

Thanks. Just a follow-up on the coated wires and then OsteoSponge SC. So, early third quarter, were you expecting FDA approval, or is that going to be potentially a little bit later? And then, if you could talk about the trial for OsteoSponge SC, the timing for that. And then, the timing also for the additional nine clean rooms.

I'll take the last one first. The nine clean rooms, we still expect them to become operational in the September/October window. It certainly streamlines our processing for our most popular products. So we think we would probably see the effects of the increased processing capabilities in Q1 of next year, 2013.

The OsteoSponge SC, the clinical study that we're performing has 75 patients. We are starting to enroll those and we expect data by mid next year to be released related to that clinical study. We'd also expect independent clinical data to be released regarding the SC sometime this year.

And the first question again was?

On the -- Guy, on the coated wires, are you still expecting FDA approval beginning of third quarter, or is that too tough to gauge?

It's always dangerous trying to guess the timeline of the FDA. Again, 13 questions that were consistent with other questions that they had asked us previously. We typically go and contact the reviewers at this point and agree on a course of action, but we don't see at this point that it would be significantly delayed.

And once you received FDA approval, how soon would you be able to ramp up production to make that commercially available?

The formula is well worked out. The production equipment is in place. It would happen very, very quickly.

Okay. And is that in the new guidance, or would that be up-side if you were able to sell some of that product in this calendar year?

That would be up-side. It's not included in this guidance.

Okay. And then lastly, on the cadavers that you are processing now, do you have a rate that you're processing those per month right now?

Yes. We are processing approximately 40 to 45 donors per month right now.

Forty to 45 per month. Okay. And by the end of the year, when you get these new clean rooms on board, I know that you said benefits of having those new clean rooms probably won't be felt until 1Q '13, but exiting 2012, how many donors per month do you think you'll be able to process?

That's certainly being based on our demand, and we may alter how many donors we are processing on a monthly basis. We will have the ability to process up to 80 donors per month by the end of the year.

Okay. And then lastly, John, maybe for you on the sports medicine distributor. I know you're going to stop focusing on doing these kind of deals where it's lower margin, but do you know how well that large stocking order to a sports medicine distributor termed out in terms of the uptake of that product? Do you have any color on that?

Yes. I think that's primarily why we wanted to start taking it on ourselves. We feel like we have to build that out ourselves now. That particular distributor didn't materialize as we thought it would. We thought it would be a good long-term relationship for us to distribute some of our slower-moving products, but we feel now that we can do it ourselves and in the long run it would be better for us -- it would be better for the Company to distribute it internally for our direct sales force.

Okay, great. I'll hop back in the queue. Thanks.

Thank you. Our next question comes from the line of Nathan Cali with Noble Financial. Please go ahead.

Hey, guys. Thanks for taking the questions. Just a couple of follow-up questions. As far as the clean rooms, how many do you have now available?

We have four dedicated to our high demand SKUs, our Osteo products. We have another room dedicated to our hMatrix with two stations. And we will be increasing that to nine additional clean rooms for the Osteo products.

And then, on the gross margin side, we can kind of see that the margin should continue as we saw in this quarter based upon the elimination of the stocking orders that you were expecting over the next several years and not going forward with that business strategy?

It's only impacted our Q4 numbers of last year, but we gave long-term guidance of 70% to 75%. And this quarter it was above that guidance, so we think that is a realistic guidance moving forward.

Okay. And should we look at 2013 as 2012 now, as far as the revenue?

It's really too early to tell. Based upon what we see at this point in time, we look at our internal models, we think that we'll come in higher in 2013 than we would have under the previous guidance for 2012. But I think as we look to the third quarter we'll have a much better idea of where we stand with 2013. So it's just a little too early to tell, especially since we're coming out of a backorder situation.

Sure. And being that, as our discussions before, and if this still rang true, 50% of your OsteoSponge revenue is basically spine revenue, so are spine procedures. Are you guys still seeing strong demand for spine procedure product demand with respect to OsteoSponge or are you seeing a strong demand for products overall? Is there any reduction in the revenue as a result of lower than expected demand?

We're still seeing strong demand across all call points. The spine is probably still about 40% to 50% of our current revenues.

Okay.

We have -- we're still seeing strong demand.

So really, the numbers are coming down strictly on the basis of change in business strategy and product supply constraints that you guys saw over the last couple of months?

Yes, exactly.

We believe so at this point, yes.

Thanks a lot for taking the questions.

Thank you.

Thanks, Nathan.

(Operator Instructions). Our next question comes from the line of Greg Garner with Singular Research. Please go ahead.

Yes. Thank you for taking my call -- my question. Most of my questions have been answered, but I missed the first minute or two, Guy, of your comments and so I just want to make sure I have this right. The revenue at $7.7 million, the difference between the Q4 was really the stock items that were delivered in Q4? Is that right?

Correct.

Okay.

You're seeing that the $1.4 million was a stocking order in Q4 of 2012, that the revenues were slightly increased or flat from the $7.7 million in Q4 and $7.8 million in Q1.

Right, okay. I just wanted to make sure I understood that correctly. And with the backorder, but there's been a shift added in March, right?

We actually started the second shift in late Q4. We didn't really see the effects of that until mid-March, so that takes a while for the --

Okay.

-- addition issues to be processed and irradiated and available to the clients, and that's approximately a 60 to 90-day delay, so that was a delay that we didn't anticipate.

Okay. So that added shift, does that add another 25%, 30%, 40% to production output?

No, it's --

50% to 60%?

Yes, probably -- at this rate, we're probably 50% to 60% right now, increase in our processing capacity.

Okay. And so just taking that forward and it seems like you -- are you building inventory, then?

We are.

Of finished product?

Correct.

And --

We have approximately a $2 million increase in our --

Overall inventory --

-- overall inventory costs, which would translate to approximately $10 million of finished inventory.

and as we mentioned, as we finished inventory, we have about $1.6 million on consignment at hospital accounts at cost, which represents roughly $6.5 million retail value of inventory at hospital accounts.

So I guess I see $10.4 million of inventory. You're saying that's all finished goods? Is that --

No. No, not at all. Remember, that's at cost, so that -- if you consider that we have a 75% plus gross margin, that $10.5 million inventory at cost translates --

Greg Garner Okay.

-- into $40 million plus retail value of inventory.

Okay. But with the additional shift, it seems like if you're processing 40 bodies a month right now, and that could support approximately $50 million, that you'd be building finished inventory.

Without a doubt. You're going to see -- as you look at the next couple of quarters, you're going to see a big increase in work-in-process inventory and finished goods inventory.

I guess what I'm driving at here is if you're building that finished good inventory, if the demand if there then it certainly seems like it could move to revenues.

Yes, that's certainly our intention.

In which case, wouldn't the revenues in the next couple of quarters be higher than what your guidance -- it seems like your guidance --

I think that what you need to factor in is -- and you know that it's not a flip-of-the-switch type of situation. You're building the inventory. But as we gain new hospital accounts, surgeons are going to maybe use the product on a trial basis, look to see how the results come for a month or two before beginning recurring ordering patterns under new accounts.

Look, we certainly expect to exceed the guidance that we've given on an overall Company basis, but I think that we feel it's prudent to give the guidance that we've given coming off of the situation with regards to the backorder and no longer doing the stocking order sales.

Okay. So even though existing surgeons who would like to order more product, you're not factoring that into your updated guidance, it sounds like.

No, I think that we'll -- the guidance is based upon the existing surgeons continuing to order at their current levels and not increasing.

Okay. Okay.

Obviously, you know it's our strategy and our plan, our sales force strategy, to increase sales, but we haven't factored that into the guidance that we've given.

Okay. And when you -- that's helpful. That's very helpful. Thank you. And when you mention that it takes two to nine months for a cadaver to clear, does that mean --? I want to make sure I understand that properly. It's not for a supply house to clear, but it's for each individual body coming in needs to be verified for lack of diseases or that sort of thing? Is that right?

Correct. There's paperwork that's related to the process and also any laboratory testing that needs to be done and serologies and bacteriologies. And some partners are faster at it than others, but the delay is two to nine months, which necessitates us to preplan for essentially nine to 12 months ahead of time what we think our demand will be.

Would that be the proper way of looking at, say, the production cycle from when a body comes in? Or is that just the clearing process and then it goes through the production process?

The production process is approximately 60 days in addition to that, to the two to nine months.

Okay. So what it means is really the bodies coming in right now are what's really going to drive revenues towards the end of this year? And then --

Yes, in the fourth quarter.

And in large part that's what created the backorder situation, is that we were relying upon this clearing process. And so, again, it's not a flip-of-the-switch. Even though we see the demand, it takes us a while to respond to that.

Okay. Okay. I just wanted to clarify a little, work through, and to finally -- the new sign-ins, the hospitals, when they sign up, then, you still need to go to the surgeons, right, to make sure that they get samples and --

Grafts.

Yes.

Even though we've gained some of these larger new facilities, it is somewhat of a hunting license to go and approach the surgeons, and you begin the sales cycle at that point as well.

And so it seems like what may also be factored into your forecast is if we have this new group of surgeons, then we want to make sure that they at least have some product to test, even though we know they won't reorder for two months later.

Correct. We won't -- it's typically consigned and each new facility will have a certain amount of consigned product. And it's very typical for a new surgeon to wait two to three months to see what the post-op x-rays look like before they feel comfortable in ordering more product. But the 140 new facilities we've signed up are in that sales cycle.

Okay. So they've already started that sales cycle, okay. All right, very good. Thank you.

Thanks, Greg.

Thank you. Our next question comes from the line of Todd Robbins with Robbins Capital Management. Please go ahead.

Gentlemen. I just wanted to get some numbers correct. The hospital inventories that you account for on your books, which is sitting at hospitals right now, do I hear correctly that you have $1.6 million in the first quarter on consignment?

Right, at cost, which equates to roughly $6.5 million retail value.

What is that compared to in the fourth quarter?

I think in the fourth quarter it was probably about 20% lower than that. And I think as you -- what will happen as we look a little forward is as our inventory goes from work-in-process to finished goods and as you look out probably over the next two to three months, you're going to see a lot more of that consigned inventory increasing as we work through the production cycle and the goods-in-process become finished goods.

So you showed over $11 million of inventory on your books, $1.6 million of which is out in hospitals.

Right.

So of the roughly $10 million that's back on your books that you're holding, how much of that is finished inventories?

I'm showing around $4 million to $6 million in cost.

Correct. How much of that is finished goods total?

Yes.

Roughly $3 million -- $3.2 million, I think, at cost, with about half of it being on consignment at hospital accounts.

You have a ton of your inventory in raw materials and work-in-progress.

Yes, a lot in work-in-process, certainly, yes.

And again, we need to do that do anticipate our demand nine to 12 months from now.

Not two months ago, you thought your processing capacity in the second quarter would be 50 bodies a month, and now you're saying it's 40 to 45. Why has that come down so, when you in the same breath say that your production issues are solved?

We think that -- we're currently processing 40 to 45 donors. I believe I said in the notes that we are going to be moving that up throughout the year. Again, it's tied to this long donor supply queue that takes us a while to clear the donors. But we do feel that the inventory issues are largely resolved, that the backorder issues are largely resolved, and there is plenty of tissue available to the sales force at this time.

Let me correct something I told you. The total finished goods is about $5 million, of which about $1.6 million is on consignment. The balance, or roughly $5 million to $6 million, is sitting in raw material and work-in-process.

Okay. So two months ago when you thought there were going to be 30 bodies processed a month and now it's 40 to 45, in the fourth quarter you had a production shortfall as well. And when we exited the fourth quarter, you thought that the production problems were largely behind you. Why do we now assume that these production problems are behind you when you've had two quarters of not fixing them?

We have more higher power levels certainly, and we have higher power levels on our consignment and we have higher power levels of finished inventory that's available. So that's significantly different than the January and February window when we were on backorder.

So your processing throughput should be improving every quarter going out and you no longer see any [log] chance in getting that processing capacity through, so it should increase quarter-on-quarter?

We expect so, yes. And to clarify one point, we were processing approximately 30 donors per month in Q4 of last year and then approximately 40 to 45 donors per month in Q1, so we've made some significant gains in our processing capabilities. But again, it didn't really show up until that March timeframe.

I recognize some of the supply issues are outside of your control. I'm just trying to get a sense for how your business is progressing and whether the production/supply constraints are over or at least improving.

As we've noted, they have improved significantly. We --

But not as significantly as you'd thought they'd improved a couple of months ago.

We're still expecting to be able to process a total of approximately 600 donors for the year.

Okay. The other question has to do more with strategy. Let's take an example. Hospital for special surgery, you're serving maybe three docs out of 20 or 25. They're one of your key markets, probably one of your biggest clients, and yet you're only serving maybe 15% of your addressable docs. With a site that's as positive in using your product as it is, why are you shipping to hospitals where you've got a long turnaround cycle instead of feeding the hospitals that are your big users that want the product?

It seems like your following a strategy which is great for the next two or three years for building your distribution across a broad range of hospitals and building out your sales force, but you're putting at risk the shareholders in the meantime by telling us there's no earnings upturn until the third quarter.

In an industry that's rapidly consolidating and an industry where your biggest competitor is falling on its face, and yet you're pursuing a strategy that puts not only the shareholders at risk, but potentially puts your Company at risk since this industry is consolidating so. Why does that strategy make sense?

I think the numbers are actually worse than that, that there are 120 orthopedic surgeons at the Hospital for Special Surgery and we have, I think, five to six surgeons that are currently using our products. And the reason that there's been slower uptake in HSS is that we have been on the backorder situation, and so it's problematic to approach additional surgeons when you're on backorder.

And that sales cycle isn't necessarily shorter for HSS surgeons than other hospitals where we have consigned inventory. So the new surgeons that we have gained at HSS are going to have the same sort of sales cycle, where, again, they'd want to see results for two or three months and then go from there.

But we are pursuing our key accounts. It is critical for us to be able to show that we can supply the larger accounts like Scripps and some other hospital facilities that we've recently signed up. We believe we are pursuing the appropriate strategy that is going to have the maximum value for the shareholders.

You have lost personally close to $24 million in the last two months and we as shareholders are down probably 50%. So instead of waiting until the end of October for your third quarter upturn in earnings, what events might happen in the next couple of months that we would look forward to as something that would be positive and a reflection of the kind of outlook you have?

Well, I share your pain. Obviously, I'm the largest shareholder. And obviously, I want to try and maximize shareholder value for everyone. But we are pursuing the strategy that provides the maximum shareholder value over time. We are managing the Company for long-term gain and I think these short-term swings are a time period that we have to bear to gain ultimate value in the long-term.

But you realize my concern is that there are companies that want to get into this space who now look at you as being vulnerable with your stock down and you run the risk of losing [your Company] by pursuing a strategy that's this long-term.

I think if there was a possible acquisition we would take it to the board of directors and they would decide if that was the appropriate course of action for all shareholders and then we would take it to a vote.

Cleveland Clinic has an order coming up -- I think it's June -- for $10 million. Is that something that you're going to announce, positive or negative?

I should clarify how that works. There is a -- it's got a request for proposal, which is, as I discussed, that typically the more complex the institution, the larger the institution, the more complex the bidding process becomes. Cleveland Clinic is expecting to have their RFPs available in June. They actually have -- what we've been able to determine is that their infused spend is approximately $10 million a year, which would not include their overall biologics spend.

But we would hope to be able to gain access to the Cleveland Clinic. If they allowed us to use their name as a potential vendor, then sure, we would announce that.

Are there any other events coming up over the next several months that we would look forward to?

I think we, again, expect to have more clinical data presented. We are -- you're going to see in our 8-K that we recently completed the study at the Hospital for Special Surgery that showed that our OsteoSelect DBM product was equivalent to antilogous bond graft, which is the gold standard in the industry. That is extremely positive data for our products, and we hope to be able to accelerate sales with that data.

Thank you very much.

Thank you.

Thank you. Our next question comes from the line of Bruce Jackson with Northland Securities. Please go ahead.

Thanks. Just one quick follow-up on the gross margins. I think last quarter, John, you said that 70% to 75% was sort of the target range that you were looking at. Is that still the range you're looking at for the year, and any changes quarter to quarter?

Yes. I think that was still -- we think now that we'll probably be at the high end of that range, but I wouldn't change the range at this point in time. I think that if you leave it consistently at 73% to 75%, I think that you're okay.

Okay, great. Thank you.

Thanks, Bruce.

Thank you. And I'm showing no further questions at this time. I'd like to turn the conference back to management.

Okay. John, do you have --?

Yes. Let me read a statement here. Before we end today's presentation, I would like to take a moment to read the Company's Safe Harbor Statement that provides important caution regarding forward-looking statements.

During this call, the management and representatives of Bacterin International may have made comments that may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are subject to significant risks and uncertainties. Forward-looking statements include information concerning the Company's future results, operations, financings, products, research, testing, employment levels, market analysis, implementation, business strategy, and expansion plans.

As you consider forward-looking statements, you should understand that such statements are not guarantees of performance or results. They involve risks and uncertainties and assumptions that could cause actual results to differ materially from the anticipated results contained in the forward-looking statements, including the Company's ability to accomplish its goals and strategies, operational and clinical effectiveness of its products, the ability of the Company's sales force to achieve expected results, FDA approval of its products, and general economic conditions.

Additional information concerning these and other factors that may cause actual results to differ materially from those anticipated in forward-looking statements is contained in the Risk Factors section of the Company's annual report on Form 10-K.

In closing, I would like to remind everyone that this call will be available for replay for one month, starting this afternoon approximately two hours after the completion of this call. Please refer to today's press release for dial-in replay instructions. A webcast replay will also be available in the Investors section of the Company's website at www.bacterin.com.

Thank you, ladies and gentlemen, for joining us for today's presentation.

Thank you, John. (inaudible).

Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation. You may now disconnect.