Xtant Medical Holdings Inc (XTNT) 2013 Q3 法說會逐字稿

Greetings and welcome to Bacterin's 2013 third-quarter results conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Rich Cockrell. Thank you, sir. You may now begin.

Thanks, Jessie, and thank you guys for joining us today. With me today are Dan Goldberger, Bacterin's President and Chief Executive Officer; and John Gandolfo, Chief Financial Officer. Of course, as most of you know, we issued a press release yesterday announcing third-quarter results for the period ending September 30, 2013. If you have not received those results, please feel free to visit the Investor Relations section at investor.bacterin.com. Following remarks by management, we'll open the call to questions. We anticipate the call to be approximately one hour.

Now, during the course of this call, management may make certain forward-looking statements regarding future events and the Company's future performance. These forward-looking statements reflect Bacterin's current perspective on existing trends; and information can be identified by such words as expect, plan, may, anticipate, will, believe, should, intends, and other words of similar meaning. Any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties, including those noted in the Company's Risk Factors section on quarterly report Form 10-Q, which will be filed next week. Actual results may differ materially from those projected forward-looking statements.

For the benefit of those of you who may be listening to the replay, this call is being held and recorded on November 8, 2013, at approximately 10 AM Eastern time. Since then, management may have made additional announcements related to the topics discussed. Please reference the Company's most recent press releases and current filings with the SEC. Bacterin declines any obligation to update these forward-looking statements except as may be required by applicable securities laws.

With that, I'd like to turn the call over to Dan Goldberger, President and CEO. Go ahead, Dan.

Good morning. My name's Dan Goldberger, and as you may know, earlier this year I was offered the opportunity to take on the role of President and Chief Executive Officer of Bacterin International, an offer that I was pleased to accept after a promising initial overview of the business. We appreciate your interest in the Company and thank you for taking the time to join us on this call.

I would like to begin by thanking John Gandolfo, Darrel Holmes, Kent Swanson, and the rest of the management team for their tireless work throughout this transition. Their hard work has allowed Bacterin to maintain an important foothold in the market. After Mister Cook's departure, John and Darrel did an admirable job preparing the Company for the incoming CEO. Their involvement in this process has been essential.

In business, the two most important aspects of a company are its products and its people. After I was approached for this position, I realized Bacterin was already blessed with world-class product and fantastic people. Our product line, especially in Biologics, is widely accepted as a leader in both quality and value. Throughout this process, I visited with many of our key accounts and surgeons, and the common thread in these meetings has been effusive praise of our allografts and clinical performance.

While Bacterin's fundamentals are strong, revenue growth has been stagnant over the last several quarters. I am working closely with our management team to identify areas of concern throughout the organization. We found, among other things, that our approach to our sales force has been counterintuitive. The model that the Company used to follow essentially punished our top performers, incentivizing them to resign and sign up as distributors. We have decided to change that model to instead compensate our top performers in an effort to retain them.

The Company is currently implementing a new customer relationship management system and other tools which will provide better visibility into our sales forecast. So I'll now go into some details about our results.

The third quarter of 2013 saw positive growth for Bacterin's Biologics product line. Excluding stocking orders from the third quarter of 2012, core Biologics revenues sold to hospital accounts grew 13.7%, from $6.7 million to $7.7 million.

Companywide revenues fell 10.7% year-over-year, from $8.9 million in the third quarter of 2012 to $7.9 million in the third quarter of 2013. Our decreased Companywide revenues reflect our decision to move away from lower-margin stocking orders. Those stocking transactions served to pull revenue forward at large discounts and ultimately created channel conflict. I believe we can build a more disciplined sales function and turn our distribution channel into a core competency for future growth.

So far 2013 has shown the resiliency inherent in Bacterin. Despite transitions in management, the organization was able to steadily maintain core Biologics revenue growth; and we are currently working on rekindling relationships that had deteriorated in the past.

Our brands, including OsteoSponge and OsteoSelect, are increasingly known as the leaders in quality and clinical efficacy. A few days ago, we announced the issuance of our first patent, and I want to take a moment to congratulate the inventors. Bacterin continues to innovate, and we have added several new product configurations so far this year. We are investing in additional programs that will support growth in the future.

Yesterday we announced a distribution relationship with DMP Spine in the European Union. DMP is managed by several industry veterans and has outstanding relationships with surgeons in the United States and Europe. DMP will accelerate our international business sooner than I had originally thought possible.

Third quarter 2013 showed a 10.7% decrease in top-line revenues, from $8.9 million to $7.9 million. I believe the revenue comparison, excluding stocking orders, is a better indication of the health of the business, since this will be our major focus in future quarters.

Biologics revenues are down 4.7% sequentially, from $8 million in Q2 of 2013 to $7.7 million in Q3 of 2013. The decline reflects seasonality in our business, as many surgeons take vacation during the summer months. In fact, that sequential or seasonality decrease was less than the decrease that we've seen in prior years. We believe that with our reinvigorated sales force, proven clinical efficacy, and renewed focus on customer service, we'll drive revenue growth going forward.

I'd now like to turn the call over to John, who will walk us through the rest of the financial results.

Thank you, Dan. As I review our financial results, I'd like to remind our listeners to refer to the third-quarter earnings press release issued yesterday, and also our Form 10-Q for the period, which will be filed next week.

For the third quarter, total revenues decreased approximately 10.7%, from $8.9 million in the third quarter of 2012 to approximately $7.9 million reported for the third quarter of this year. The decrease was primarily attributed to $1.85 million in stocking orders reported in the third quarter of 2012.

As Dan mentioned, excluding stocking orders, revenues increased 12.9% over 2012. Total revenues in the third quarter decreased 4% sequentially from the second quarter of 2013 revenues, reflecting the seasonality of the market. It is important to note here that we are seeing strong indications of the stabilization of revenues generated from our core hospital business, as evidenced by the year-over-year growth of our core Biologics business.

Gross profit for the quarter was $4.6 million, and this compared to $6.3 million for the third quarter of 2012. Gross margin for the period was 58%, which compares to a gross margin of 71% reported in the same period last year. The decrease in gross margin was primarily due to a changing product mix, lower average prices due to increased competition, as well as contract obligations with our GPOs, and the discarding of certain products as we improve our manufacturing process. Excluding the impact of these product discords, gross margins were 61.4% in the third quarter of 2013. We are currently in the process of analyzing in detail our manufacturing process as well as related inventory levels to determine the appropriate costing method and model as we go forward into 2014.

Sales and marketing expense for the third quarter increased to $4.1 million as compared to $3.4 million for the same period during 2012. As a percentage of revenues, selling and marketing expenses increased to 51%, which compares to 38% reported for the third quarter of 2012. The increase was primarily the result of the third-quarter of 2012 stocking orders being recorded with no commissions earned, which contributed to the unfavorable variance when comparing it to the third quarter of 2013. In addition, it was a shift towards distributor sales at higher commission rates and an incentive program to promote sale of our excess slower demand inventory.

Sales and marketing expenses in third quarter of 2013 was 51% of revenues. General and administrative expenses for the quarter were approximately $2.8 million, a 13% increase over the comparable period during 2012. This represents 35% of our revenues in 2013 compared to 27% of revenues in 2012.

G&A for the third quarter included a $642,000 increase in our Accounts Receivable reserve due to the slower collectability from our prior-year stocking order sale. This increase was partially offset by lower salary costs resulting from our previously-announced reduction in workforce earlier this year. Excluding the reserve increase, G&A was approximately $2.1 million for the quarter.

Operating expenses for the period were $7 million compared to operating expense of $6.1 million in 2012, an increase of 15%. Net loss for the quarter was $4.4 million or $0.08 per basic share, and this compares to a net loss of $2.5 million or $0.06 per basic share for the third quarter of 2012.

EBITDA for the third quarter was a loss of $1.8 million, which compares to a gain of $820,000 last year. Excluding the increase in the allowance for doubtful accounts of approximately $650,000, EBITDA was a loss of $1.15 million in the third quarter.

We believe that our September 30, 2013, cash on hand and accounts receivable balance of $8.1 million, combined with anticipated cash receipts from sales expected from operations, expense reductions, and access to additional capital resources will be sufficient to meet our anticipated cash requirements going forward. We will continue to focus on executing our strategy and remain optimistic about the opportunities in front of us, and this includes the conversion of new sales strategies that we are pursuing.

As I mentioned, for a more detailed and complete analysis of our third-quarter results, I'd like to direct everyone to our Form 10-Q, which we plan to file with the SEC next week and which will be available at www.sec.gov and be on our website. I'd now like to open the call to questions.

(Operator Instructions) Matthew O'Brien, William Blair.

I was hoping you guys could just start off with how we should be thinking about Q4, here, given what we saw in the third quarter? And then, I'm not sure if you want to even get into 2014 at this point, but just the general trajectory and the way to think about things next several quarters?

Matt, thank you for joining the call. We are quite a few weeks into the fourth quarter, and we are tracking similar kinds of run rates that we've seen earlier in the year. There is some seasonality in the business, as I mentioned. We're making some changes in the sales force which will become effective in the first quarter of 2014. And I'm very excited about 2014, but we still have a lot of work to do to build that foundation.

Okay. So along those lines, Dan, how should we think about the turnaround process going forward? It sounds like with some of those adjustments in the sales force, Q1, Q2 could be fairly soft. And then, obviously, Q3 of next year will have the seasonality in it. And then -- is it really kind of Q4 next year we should focus on in terms of how things are progressing?

I'd love to tell you that things will go faster, but I think what you just outlined is a realistic, conservative approach.

Okay. And then on the distribution agreements, you guys have been doing a fair amount internationally in recent months. How should we think about that contributing to the next year and in the coming years?

When you say we've been doing a fair amount, we've been doing some -- we've been working on it. Our revenues are largely --

Trailing from international --

Yes, our trailing revenues were immaterial from international, just to clarify.

Sure.

And the international business, especially the -- our entree into the European Union in partnership with DMP Spine is all upside to what we've been doing inside the Company. So we're not planning for it, but we are optimistic that that will get traction ahead of schedule.

Okay. Any sense for potential contributions from a revenue perspective next year, too?

You know, we've shipped over $100,000 to that channel so far this year, so --.

Okay. And then you're mentioning all these compensation changes and distribution commentary. Can you just provide a little bit more color on exactly what that means for your distribution going forward? How much is going to be distributor, how much is going to be direct reps; and then the impact to the operating expense line?

So we're going to continue to have a blended organization of direct sales reps, where we have strength in that channel; and distributor straight commission reps, where we have strength in that channel. And allow me to be a little bit vague about the rest of the reorganization until I roll it out internally.

Okay. And the last one for me, and this is probably for John. The cash balance that we're looking at now -- and given the burn rate we saw in the quarter, you know, with just the confidence level that you won't be needing cash in the next several quarters? And you said to meet your operational demands going forward. Over what time frame are you projecting there?

Well, I think that the statement was that with the revenues, as well as with potential reductions, as well as some additional capital resources, we would to meet our cash obligation. So the statement was made looking out over the next 12 months or so. But where -- the cash need will totally be dependent upon where the sales levels come in over the next few quarters. So we're analyzing now what channels are available for us to get additional cash into the Company.

Suraj Kalia, Northland Securities.

So, Dan, what was the product mix in the quarter for direct versus distributors?

It was -- in terms of percentage, it was about one-third coming through the direct sales force, two-thirds coming from the distributors. Some of the distributor number, though, was -- in certain markets, the distributor's working with that direct sales force.

Fair enough. And to quantify the direct reps, where do we stand now; and where will we be, let's say, in the next 6 to 8 months?

We've got 20 direct sales reps, and then a sales management organization above that. And allow me to be vague about forward-looking plans until I've had a chance to roll them out inside the Company.

And how many distributors do we currently have?

We have about 160 distributors.

Currently marketing the product as well.

Right.

Fair enough. Dan, obviously you've come in, and as much is all of us would like to be gratified tomorrow, there is a certain time period that is needed for you to reshape the business, correct what you perceive as wrong.

Given that carry out, and all of this will take time, can you help us? For this quarter, help me reconcile -- the gross margins decreased, and from what we read, moved to a direct sales -- more emphasis to its direct sales. But then SG&A also increased to shift to distributors at higher commission. Just wondering if you can walk us through or reconcile those two and help us model it out for looking forward?

Suraj, let me address the distribution side first, and then I will hand it over to John on the gross margin question. Our nomenclature is a little bit confusing.

What we're moving away from are the stocking orders that the Company did on occasion in the past. If you look at our history, there were a handful of large, sort of lumpy stocking orders with some aggressive terms to them; and that's the kind of transaction that we will not be doing in the future.

In the same breath, we are fully committed to the distributor relationships that we have. And in our nomenclature, those distributor relationships are a large number of dedicated professionals out there who get a straight-commission kind of a compensation from the Company. So I wanted to clarify that when we talk about our direct channel, it is a hybrid channel that has direct sales reps who are employees of the Company, and then a larger number of professionals who represent the Company and get a straight commission but are not technically employees of the Company.

So that's the channel -- that blended channel of direct sales reps and distributors, or rather, straight commission representatives that we are focusing on going forward in order to support the brand; develop the relationships on behalf of the Company; and longer-term, generate growth in both aspects of the operations, top-line and contribution.

Suraj, with respect to your question on the gross margin, in the quarter we did report a roughly 58% gross margin. We are doing an in-depth analysis of our whole process at this point in time, and we expect that to be completed probably over the next 6 to 8 weeks or so.

And what we're trying to ascertain is, going forward, what will the margin be without any of these extraordinary items that we've seen in the past? So right now we believe that there's probably 5% to 7% more gross margin that we expect to report as we look at 2014 and beyond. Somewhere 63% to 65% on a continuing basis.

But we are refining our process for certain of our products, and that's reflected in roughly 3% of our gross margin. So as I mentioned, excluding the refinement that we're doing, we would have reported gross margins of about 61%. But I think the best way to look at it -- that assuming constant dollar pricing and that the sales price for the product remains stable, we do believe that there is probably another 3% to 5% of gross margin as we look to 2014 and beyond. But we'll know much better as we complete this analysis that we're in the process of doing.

Fair enough. And one last question, Dan. I guess somewhat tangential, but nonetheless, I hope I can ask this. Dan, your views on all the tissue graft issues taking place, with the 361 letters and proposed package reimbursement -- how do you all on view it, and if at all, your need to rejig any of your products, presumably in a newer environment. Thanks for taking my questions.

No, certainly. And we're watching both of those trends very carefully. As you know, the FDA and other regulatory agencies have been looking carefully at this segment of the business. We are working through the remaining open items from the warning letter that we received.

We do not anticipate any change in the classification of our flagship products -- OsteoSponge, OsteoSelect on the orthopedic side, or hMatrix on the soft tissue side. We're pretty clear on what those classifications are.

As far as your second question about the gradual change in reimbursement for those procedures, we're watching it carefully. We are staying close to our physician advisors. The Company has had remarkable success building relationships with the GPOs, building relationships with various IDNs. In the short term that has challenged our pricing somewhat, getting on those contracts, but in the long term gives us much broader reach and much more credibility as we call on larger numbers of physicians and institutions.

Greg Garner, Singular Research.

At the very beginning of the call, I was pulled away, and so I didn't hear the prepared remarks on the change in the marketing. But based on what's been discussed so far, I think I've got the gist of it. And I just want to reiterate that to make sure I'm looking at it properly is that -- Dan, you're considering refocusing the marketing structure, but to really focus on those internal salespeople and external distributors that are performing well, and compensating them at a higher level to incentivize that continued performance and weed out those who aren't performing well? Is that the right way to look at this? But the whole plan's not totally gelled yet, but that's the direction you're going in?

Absolutely. We are streamlining and clarifying our compensation plans for our direct employees. Our distributor relationships are going to remain intact, and we're going to continue to expand those distributor relationships where it makes sense.

The part of the call that you may have missed is, especially in looking at our Q3 financials, there was a large stocking order in the year-ago period; and John and I are looking at the Company as one that relies on day-to-day sales from our own organization, moving away from the one-time large stocking orders that make it very difficult to compare the business to the year-ago period.

Okay, yes. It just seems like a good step to take here. What are you seeing out there in the market right now, as far as any uptake from relatively new surgeons that are new to the Bacterin products -- the OsteoSponge and OsteoBody and such -- or potentially the new hospitals that have signed up? Or any flavor on that to where we can get a sense for the receptivity of the product in the marketplace?

I think there are some positive signs. If you look at our core Biologics business being up 13% year on year, I think that signals that our -- and we look at two metrics in there. There is the existing accounts buying more per month, using more of our product per month; and then on top of that, there's some new accounts being added. And then I can in my prepared comments -- I take some comfort from looking at our core Biologics business, the number of transactions we're doing, the average size of transactions. Those metrics are going in the right direction.

Okay. Yes, it certainly seems like the core Biologics growth is good there. Is the hMatrix -- is there any details you can tell us on how that's ramping up?

We've got a significant number of trials and samples going on right now. And I'm a salesman, so I am eternally optimistic that I'll close each and every one of them. But we need another 4 to 6 months to see if we can pull those accounts through to regular customers.

Okay, and then just one item on the gross margin. I guess it might be for you more, John -- it sounds like there might be some production items that you can streamline or improve? Or is there -- which makes me wonder -- that could happen potentially soon, or is that pushed out a few quarters? It sounds like it could happen soon when you mentioned how gross margin this third quarter could have been above 3 percentage points higher already.

Yes, I think that certainly we expect it to happen in 2014. You know, the Company's processing methodology has changed over the last 4 to 5 years. We initially started out basically producing as much product as we could from each donor. And what we've come to the realization is that by doing that, you are minimizing your waste, and you're creating salable inventory.

But a lot of that inventory, as we have found out, ends up being low-demand inventory. So as I mentioned, we're doing this in-depth analysis to determine what is the optimum type of products that we're going to be generating from each donor, and how can we do it in the most cost-effective and cost-efficient way as we get into 2014? So we do expect that the work we're doing on this analysis in the gross margin to certainly kick in during the beginning of 2014.

Okay. And one thing else that comes to mind -- on the EU distributor, what countries are they focused on?

They are strongest in South Europe right now, but there are other partnerships developing with DMP as the master importer that will allow us to get into the UK, and Benelux, and the larger Northern European territories.

So DMP would act as sort of like your European main distributor, that would then farm it out to other country-specific distributors? Is that the general idea?

Yes, there is a nuance to get in Biologics into the EU. DMP is going to be our primary importer because of their standing as a tissue bank in that territory.

Todd Robbins, Robbins Capital Management.

I know it's hard to discuss the changes that you're contemplating on the marketing side, but I guess from a summary point of view, marketing has been the Achilles heel for this Company for quite some time. So maybe at a high level you can help us get our arms around a metric that may give us some food for thought.

John indicated that a third of the $7.7 million in sales came from your direct salespeople. And you mentioned that you've got 20 of them. So that means that in the quarter, the average sales guy did about $125,000. So on a yearly basis that's about $0.5 million.

What should these guys be thinking about -- or what do you think a good salesman should be able to generate in revenues? I put it that way, because we could address the sales issue by just hiring a bunch more people, which may be an option; or we could address the sales issue by saying, we need sales per rep to go up. So if I just look at the latter, at the sales per rep, what should a good salesman in this industry do in terms of revenues? And what do you think you can do to stimulate that?

So you're thinking about it in the right direction. There are two parameters here. The one that you're identifying, the revenue per headcount. The other parameter is the revenue per transaction, and that starts to tell you how many transactions each individual in the sales force has to participate in. And there is a concept in this industry of covering cases, and we have to figure out how to cover those cases, because each one of those cases represents another transaction, and therefore some more revenue for the Company.

With respect to our sales organization, I need -- I can't share those numbers with you just yet. There is public domain information. For example, Wright Medical has been reporting that their sales force is in $680,000 to $690,000 a head; and their goal is $750,000 per head. And I think those are reasonable targets. But you're correct in looking at our numbers and seeing sort of that $500,000 per head.

Thank you. The attraction all along has been the size of the addressable market and the small penetration that you've had in getting into that space. Wouldn't it make sense at some point, if you can't get the traction you need, to consider some kind of a joint venture with another company for helping jumpstart your revenues?

We are studying the business in some of the other segments where we're not as strong. In sports medicine, in plastic surgery, in wound therapy. We've got a variety of conversations going on. I'd be much more reluctant to do that in some of our core competencies -- in orthopedics and in spine, where we are developing our brand, where we do have some recognition and respectability today. But absolutely, we're very open-minded about how to drive market share.

My last question relates to the European opportunity. I guess the two ways for us to think about it would be, what do you see as the market opportunity for the Southern European exposure that DMP gives you as a market opportunity? And then, secondly, what would you be comfortable dialing in as the kind of revenue that might be achievable in a year or 18 months from that source?

So in terms of our models, we are not putting anything in for revenue from that source. Even though we're very optimistic about their ability to penetrate the channel, we still have to build the reference accounts, establish the credibility of the product in those marketplaces; and in Europe, those processes tend to take longer.

That said, and that's the conservative view, it's entirely possible that that channel starts to generate material revenue as soon as the first half of 2014. We could get lucky.

And what do you see as the market opportunity?

Longer-term, the EU appetite for Biologics is about two-thirds of the US appetite, but the pricing is more challenging.

Yes. I think it comes out to around 50% of the US opportunity --

On a dollar basis -- on a revenue basis.

Yes, on a dollar basis.

(Operator Instructions) Danny Frank, Private Investor.

John, in the last two 10-Qs, there was a discussion about violation of the loan covenants. And when you look at the balance sheet with, now, no equity; losing money. All indications are you're going to continue to have cash losses for at least the next quarter or two. Where do you stand on your covenants, and what of the terms of the covenants? And are you in violation again, and will that be disclosed in the 10-Q?

We were in violation this quarter of the revenue covenant, and we are currently in discussions with OrbiMed to get the waiver, which will be included in the 10-Q this quarter.

And what are the conditions of the waiver?

We haven't disclosed that yet -- we haven't even finalized that yet.

What were the conditions on the last waiver?

I believe that was -- I think it might have been an exit fee of $200,000, but don't quote me on that.

It'll be in the Q, right?

Yes, it will be disclosed in the Q.

Okay, but then how do you address the absence of cash? If you burn out cash in the next two quarters, how are you going to address the note -- the unavailability of cash?

Well, as I mentioned, we're going to have to look for a number of capital resources going forward. And we're doing that now. We're exploring what opportunities are out there from a capital infusion standpoint.

Okay. And then, Dan, one question. The big issue for the Company has been -- and for some reason, never seems to be addressed -- is you're competing against Medtronic, that is selling a cage, or screws, or all the hardware, also; and a biologic in a package that's going into a customer as a packaged account at a winner-take-all pricing, which is the way the purchasing managers are doing it all. And you guys are walking into a marketplace with no, if you will, suitcase of products to sell in order to compete on a head-to-head basis. How are you going to address that?

Well, you're absolutely right. Medtronic is the 800-pound gorilla in this space. But don't underestimate their ability to leave some seeds for smaller players like us. We have 4 GPO contracts now. We have half a dozen IDN contracts now, which just demonstrates that in spite of all of their marketing clout, they continue to leave opportunities open for us to make inroads.

We need to execute. It's not -- for us to get material revenue growth, I don't have to deal with Medtronic; I just have to execute on the relationships that the Company has already put in place.

Really. Okay. Thank you.

Okay. Are we done?

Thank you. Ladies and gentlemen, it appears there are no further questions at this time. I would now like to turn the floor back over to Mr. Goldberger for any concluding comments.

Well, thank you all for tuning in. As you know, it's been a challenging transition. I'm optimistic about the future. Have a great day.

Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.