Xtant Medical Holdings, Inc. (XTNT) Q1 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Bacterin International Holdings Inc. First Quarter 2012 Earnings Conference Call. [Operator Instructions] Today’s conference is being recorded May 03, 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 in an increase of 29% compared to $6.0 million in the first quarter of 2011. Excluding $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. Although revenue was lower than anticipated due largely to 6 of our top 10 product categories being on backorder 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 now on [ph]. Inventory increased 25% 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 the cost on consignment of hospital accounts, which translates to approximately $6.4 million of inventory at retail value. Investor is now readily available to our sales force, and by the end of the first quarter we have signed on additional 140 facilities. We are optimizing our processing facilities to meet demand for our products including hMatrix, which we believe will be a positively impacted under new reimbursement terms. Margins returned in north of the 70% to 75% range that we’ve guided for to 76%, and at March 31, 2012 we had approximately $1.4 million in cash with the newly at Access to approximately $3.8 million and our non-diluted revolving accounts 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 will return to give a more detailed operational update and a look ahead. Then we will 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 sales 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% to 75%. The fourth quarter of 2011 gross margin figure was negatively impacted by approximately $1.2 million of nonrecurring charges as well as a lower 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 $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 $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 recorded 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 our use of EBITDA, our 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 equivalents and net accounts receivable was $9 million at 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-diluted revolving AR credit facility, which we close 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’s filed with the SEC in March 2012 as well as the company’s Form 10-Q, which will be file later this week, which will be available at www.sec.gov and via our website. Now, I’ll be happy to answer any questions you may 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 request for proposals for major institutions such as in Scripps Health hospital system, which we recently gain access to. Our products maybe is 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 was building a sales pipeline and we are in the process of hiring another 10 to 12 representatives by the beginning of the third quarter. We recently own our third GPO contract, a 3-year agreement with a leading health care supply chain expertise and contracting company to provide OsteoSponge, OsteoSelect DBM Putty, OsteoWrap, or OsteoLock, or BacFast, hMatrix, or Sports Medicine Allografts, and a 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 have in Q1 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 our predetermined formula for borrowings about to 80% of Bacterin’s eligible accounts receivable, as defined in the credit and security agreement. Additional working capital provided by [indiscernible] our revolver and we will be terminating in Lincoln Park Capital of equity line. We are confident we had now overcome on short-term production issues. However, beginning the quarter with SKUs on product goes on backorder and unavailable to convert new surgeons. This slows 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 1 or 2 cases made with typically wait 60 to 90 days to see if they like the results, before we begin ordering in greater volume. When product is constrained and goes into backorder, it delays the uptake and the growth we’ve historically experienced and is 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, and continue to build our pipeline to building these new accounts into meaningful recurring sales will take longer than as originally anticipated. hMatrix [indiscernible] implantation at faster vascularization rates is gaining the attention with clinicians 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 necessary Q code by mid-May, which will become effective January 1, 2013. We also made improvements with respect to the product size of the hMatrix that we expect to yield higher sales over the last 3 quarters of 2012. We continue to have export clinical results per products with over 110,000 implants to-date with no adverse event. In April, a peer review article in Orthopedic Research and Reviews determined OsteoSponge exhibits ideal properties for bone regeneration, similar to those of autograft, graft of patient’s own bone with a distinct advantage over autografts, being that there is no risk of complications at the harvest site or donor pain postoperatively. We are very pleased to have this paper to show 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 autologous bone graft in the posterolateral intertransverse rabbit model. This statement will be used to gain additional indications of OsteoSelect DBM such as craniomaxillofacial and as expected help drive sales in the remainder of 2012 and 2013. The OsteoSelect DBM putty proved equivalent to autologous bone graft, which is the current gold standard for spinal fusion. While we are treating nearly 200 patients with our OsteoSponge SC product, we expect independent data on OsteoSponge SC for treatment of osseous defects before the end of the year. As positive clinical developments continue in this area represents an enormous opportunity for Bacterin shareholders. As per quality guidance, because our industry sells product on a consignment basis, we have poor visibility on reportable revenues until 1 or 2 weeks after the close of a 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 showed an 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 is 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, will be expanding the number of clean rooms we devote to high demand products to a total of 13. Our plan is to optimize production to processing for a high demand products and expect processing capacity to double from current levels by the end of the year. In addition, we are also ramping up our donors from our current $40 million to $45 million per month, of $60 million by the end of Q1 and eventual to $80 million 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 as margin, due to the large addressable markets, demand from our current plans and acquisition of new and larger accounts. There is a lag time with processing capacity since it takes approximately 2 to 9 months to clear a donor because it relates 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. Lisa, please provide the appropriate instructions.

[Operator Instructions] Our first question comes from the line of Matthew O'Brien with William Blair.

I was hoping I could get just from a housekeeping perspective Osteo product, hMatrix and medical supplies revenue in the quarter?

I’m not sure that we -- Matt, this is John speaking. I don’t think that we have the breakdown available right here, and 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 compared to the other products.

Yes. I’d clarify, I think that OsteoSponge and Wrap will be approximately 65% or 70% of the sales approximately 15% to 20% of our DBM putty being balanced. The hMatrix is still a relatively small percentage by 2% to 5% this range. But we do expect hMatrix to be significant contributor to revenues in the balance of the year, and we’re still projecting approximately 5% to 10% of revenues for both this year and next to be our hMatrix products?

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 the distributors no longer, are not selling to these distributors, some of these floor-moving products. I’m estimating that cost you about $3 million to $4 million this year. You’re taking guidance down by $18 million, $19 million, and the only issued guidance are reiterated at about 5, 6 weeks ago. So what is it that changed here in such a dramatic fashion?

Well, first of all, the stocking orders for distributors represented about $7 million. And we just decided that we were not going to pursue those. So that’s one major change in terms of guidance. The balance is primarily due to the delays in terms of the reimbursement on the hMatrix, which are going to push back those revenues from these products as well as the production issues that were 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 used in the products for 6 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 a similar reorder rates as they have historically. When we attributed the lack of 15% to 20% growth through the production constraints, that’s even though surgeons have these products 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 6 key products?

We exited the backorder situation probably mid-March and now we feel we’re in very good shape moving forward.

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

I think going back to, when we process our back orders, it slows down the sales cycle and the uptick. We feel that we’re going to take a while to gain some additional accounts we originally expected, and we’re basically being pushed back by 2 quarters, not originally anticipated.

Okay. And then one more for me John, can you just -- exiting March, give us a sense for what your [indiscernible] exiting March, just given that you just did this revolver. But as this 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 $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 Lincoln Park equity line.

Our next comes from the line of Caroline Corner with MLV.

This is Yumi in for Caroline. First of all, have you had any communications with the FDA regarding the coatings business?

Yes, we have. We received 13 questions back. They’re typical what we received back in prior submissions. We expect to the meeting with them within the next 30 days, that’s responded those questions. We continue to answer the questions and we, at this point expected to be similar to the other experiences where we had with the FDA, where it’s taking 2 to 3 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 on breast reconstruction that those will be the 2 kind of major indications for hMatrix, at least right now?

Right now, we’re gaining lot stronger certain uptick in the breast reconstruction market. It’s not subject to reimbursement code 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 significantly greater uptick in the next few quarters?

Our next question comes from the line of Bruce Jackson with Northland Securities.

First, with the sales people, can you tell us the number of reps and sales managers’ and the total sales force numbers?

Right now, we have approximately 50 direct reps, we have offers to 10 more, that we’ll be hiring in next 6 weeks in that timeframe. and then we have 15 -- actually I have to think about, we have 13 RVPs, Regional VPs, we have 2 EVPs, and a national sales manager, we also have 5 people in our customer service force as well.

Okay. So that gets us over 70. Then with the revenue that’s a 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 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 acute code in May for the hMatrix product, and it’s not actually going to go into effect until 2013, or can you explain that?

Yes. The pivotal process takes place throughout the year before it’s actually effective. So it will go effective January 1, 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?

It’s still too early to tell, I think the partner levels are strong as it’s ever been with the company like with our most popular products. And I think we’re definitely expecting our growth through the quarter, 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 gain? So would you expect that revenue would be up sequentially in Q2 or about the same level as in Q1, how do you think the revenue is going to build for the rest of the year?

I think as we mentioned, we expect the sales increase associated with backorder, it should have been alleviated to begin showing up on a 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 and fourth quarter, much higher growth rates on a sequential basis.

Okay. And with the coated 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.

Our next question comes from the line of Anthony Vendetti with Maxim Group.

Just a follow-up on the coated wires, and then OsteoSponge SC. So is early third quarter -- you’re 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 9 clean rooms?

Yes. 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 -- we’d 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 at least related to that clinical study. We also expect independent study or independent clinical data to be released regarding the SC sometime this year. And the first question again was...

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

Well, it’s always dangerous Tony, yes, 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 the course of action. But we don’t see at this point that would be significantly delayed.

And if you, once you received FDA approval, how soon will 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 upside, if you were able to sell some of that product in this calendar year?

Yes, there will be upside, it’s not included in this guidance.

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

We’re processing approximately 40 to 45 donors per month right now.

40 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 it will be fell to 1Q ’13, but exiting 2012 how many donors per month do you think you’ll be able to process?

It’s only based on demand we may alter how many donors we are processing on monthly basis, we’ll have the ability to process up to 80 donors per month, by the end of the year.

Okay, and then lastly John, obviously on the sports medicine distributor, I know you’re going to stop focusing on doing these kind of deals where slower margin, but do you know how well that large stocking order to a sports medicine should be 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 want to start figuring on ourselves, we feel like we have to build that out ourselves now that particular distributor didn’t materialize as we thought it would and we thought it would be a good long term relationship for us to move to distribute some of our slower moving products, but we feel now that one, we can do it ourselves and that would be in the long run to be better for us, it would be better for the company to distribute it internal drag to our sales force.

Our next question comes from the line of Nathan Cali with Noble Financial.

Just a couple of follow-up questions and as far as the clean rooms, how many do you have now available?

We have 4 dedicated to our high demand SKUs or Osteo products. We have another room dedicated to our hMatrix with 2 stations, and we’ll be increasing that to 9 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 on this quarter based up on 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 the last year, but given the long-term guidance 70%, 75%. And now in this quarter, it was above that guidance and we think that as realistic guidance moving forward.

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

It’s too early to tell, based upon what we see at this point, Tom we look at our internal models, we think that we’ll come in higher 2013, and we would have under the previous guidance ’12, 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 little too early to tell especially since we are coming out of the back order situation.

Sure. And being that as in the discussion before and if this still rings true, 50% a year of OsteoSponge revenue is basically spine revenue -- sorry 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. But 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 in the last couple of months.

We believe so at this point, yes.

[Operator Instructions] Our next question comes from the line of Greg Garner with Singular Research.

Both of my questions have been answered, but I missed the first one or 2, Guy, your comments, so just want to make sure I have this right; revenue 7.7, the difference between Q4, which really the stock items that we are delivered in Q4, is that right?

Correct. So you’re saying that the 1.4 million was the stocking order, in Q4 2012 that the revenues were slightly increased or flat from the 7.7 million in Q4 and 7.8 million in Q1.

Right, I just want to make sure I understood that correctly. And with the backorder but there has 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, it takes a while for the additional tissues to be processed and irradiated and available through the science that’s approximately 60 to 90 day delay, that was delay that we didn’t anticipate.

Okay so that added shift, did that add another 25%, 30%, 40% to production output?

At this rate we were probably 50% to 60% right now increasing our processing capacity.

Okay. And so I mean taking that forward and it seems like you, are you building inventory then [indiscernible] of finished product?

Yes. Approximately $2 million increase in our…

Overall inventory…

Overall inventory cost, which will translate to approximately $10 million of finished inventory.

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

So I guess I see $10.4 million of inventories, you’re seeing that’s all finished goods?

No, not at all remember that’s our cost, that’s an -- if you consider that we have a 75% plus gross margin that $10.5 million inventory at cost translates into $40 million plus retail value of inventory.

Okay, so with the additional shift it seems like if you’re processing 40 bodies a month right now and that could support approximately $50 million, you’d 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 and process inventory and finished goods inventory.

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

Yes, that’s certainly our intention.

And in which case, wouldn’t it’d be revenues in the next couple of quarters be higher than what’s your guidance, seems like your guidance...

Well, I think that you need to factor in is that it’s not a flip of a switch type of situation, you’re building the inventory, but as we gain new hospital accounts, searchings [ph] are to going to maybe used a product on a trial basis, look to see how the results for a month or 2 before beginning with current ordering patterns, on the new accounts. Look I mean we certainly expect to receive the guidance that we’ve given on our 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 back order and no longer doing the stocking the order sales.

Okay, so even though existing surgeons who would like to order more products, you’re not factoring that into your updated guidance sounds like.

No, I think that will, the guidance are based up on the existing surgeons continuing to order out at their current levels and not increasing. Obviously, with 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. When you mentioned it take 2 to 9 months for a cadaver to clear that means, I want to make sure understand properly, it’s not for a supply house to clear, but support each individual body coming in needs to be verified for lack of diseases and that sort of thing, is that right?

Correct. There is paper work. It’s related to the process and also laboratory testing easily done zoology and even bacteriology, and some part of the reserve [indiscernible] with the knowledge but the middle way is 2 to 9 months which necessitate us to pre-plan essentially 9 to 12 months ahead of time what we think our demand will be.

It is that would that be the proper way of looking at see the production cycle from when a body comes in or is that just declaring process and then goes through the production process.

The production process is approximately 60 days in addition to that to the 2 to 9 months.

Okay. So what it means is really, the buys come in right now or what’s really going to drive revenue towards the end of this year.

Yes [indiscernible] in fourth quarter.

And in large part that’s what created that math for where our situation is at. We are inline upon with this clearing process and so again, it’s not a flip of a switch, even though we see the demand it takes us a while to respond to that.

Okay. Okay I just wanted to clarify how that all works through and just finally, the new signings the hospitals. When they sign up then, you still need to go to the surgeon’s right to make sure that they get samples and…

Correct. Even though we regained some of these larger new facilities it is somewhat on the holding lines since to [indiscernible] approach the surgeons and you begin the sales cycle at that point as well.

And so, it seems like what maybe also be factored into your forecast is this. 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 2 months later. And so…

Correct. We won’t -- it’s difficult consigned and each new facility will have a certain amount of consigned product, and it’s very difficult for a new surgeon to wait 2 to 3 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.

Yes.

Our next question comes from the line of Todd Robbins of Robbins Capital Management.

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

Right. That cost which equates to roughly $6.5 million retail...

What does that compare 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 is that they look a little forward is that, as our inventory goes from work on process to finished goods then I should look out probably over the next to 2, 3 months, you’re going to see a lot more of that consigned inventory increasing as we work through the production cycle and the existing process become finished goods.

So you showed over $11 million of inventory on your books 1.6 of which is out on hospitals. So that’s roughly 10 that’s back on your books that you’re holding. How much of that is finished inventories?

[indiscernible] $11.6 million cost.

Correct. How much of that is finished goods in total?

Yes.

Roughly $3 million, $3.2 million I think across with about half of it being our consignment at hospital accounts.

But you have a ton of your inventory in raw materials and work in progress.

Yes. A lot work in process certainly, yes.

And again, we need to do that to anticipate our demand 9 to 12 months from now.

Not 2 months ago, you thought your processing capacity in the second quarter would be 50 bodies a month, and now you’re saying its 40 to 45. Why has that come down so, when you are in the same breath say that your production issues were solved?

And we think as the only -- we’re currently processing $40 to $45. I believe I said in the notes that now we’re going to be moving that out throughout the year. Again it’s tight to this long donor supply queue that takes us a while for the donors. But we do feel that the inventory issues are largely the result that the back order issues are largely resolved and there is plenty of tissue available to the sales force if there is time.

So, let me correct something I told you. The total finished goods is about $5 million and for which about $1.6 million on consignment. The balance were roughly $5 million to $6 million, and I’ll say again, raw material in working process.

Okay. So, 2 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 short fall as well, and when we executed the fourth you thought that was the production problems were largely behind you. Why do we now assume that these production problems are behind you when you’ve had 2 quarters of not fixing them?

We have more higher car levels certainly, we have higher car levels on our consignment, we have higher car levels at finished inventory that’s available, so that’s significantly different in the January, February window when we are 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. So that should clarify at one point. We’re processing approximately 30 donors per month in Q4 of last year, and then approximately 40 to 45 donors per month in Q1. So we made some significant gains in our processing capabilities. But again, it didn’t really show up until that March timeframe.

I recognized some of the supply issues were 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?

Everything else we’ve improved significantly. We’re still expecting to be able to process a total of approximately $600 for the year.

Okay. The other question had to do more with strategy. Let’s take an example, hospital for special surgery, you’re serving maybe 3 docs out of 25. They’re one of your key markets, probably one of your biggest clients and yet you are only serving maybe 15% of your addressable docs. With the sight that’s as positive and using your product as it is, why are you shipping to hospitals where you’ve got a long turn around cycle instead of feeding the hospitals that are your big users that want the product. I mean, it seems like you’re following a strategy which is great for the next 2 or 3 years for building your distribution across the 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 is no earnings up until the third quarter. In an industry that’s rapidly consolidating, in an industry we are biggest competitors falling on space and yet you’re pursuing the strategy that puts not only your shareholder at risk, but potentially, but your company at risk since this industry is consolidating itself. Why does that strategy make sense?

I think, the numbers were actually worse than that. There are 120 orthopedic surgeons in hospital for special surgery, and we have I think 5 to 6 surgeons that are currently using our products. And the reason that there has been a slower uptick in HSS is that we have been on the backorder situation and so, it’s problematic to approach additional surgeons. When you are on back order and that sales cycle isn’t necessarily shorter for HSS surgeons then hospitals where we have consigned inventory. So the new surgeons that we do at gain at HSS are going to have the same sort of sales cycle again, whereas they want to see results for 2 to 3 months, and then they go from there. We are pursuing our key accounts, it is critical for us to be able to show that we can supply the larger accounts like strips and some other hospital facilities that we recently signed out. We believe we are pursuing the perfect strategy that is going to have the maximum value for the shareholders.

You’ve lost personally close to $24 million in the last 2 months, and we as shareholders should are [indiscernible] probably 50%. So instead of waiting till the end of October for your third quarter up turn and earnings, what events might happen in the next couple of months that we would look forward to as something that would be positive in reflection of the kind of outlook you have?

I share your pain. Obviously I’m the largest shareholder and that, obviously I want to try and maximize shareholder value though everyone. We are pursuing the strategy that provides the maximum shareholder value over time. Now, we are managing the company for long-term gain, and I think these short-term swings are time periods that we have to bear to gain ultimate value in the long-term.

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

I think if there was a possible acquisition, yes, we would take it the Board of Directors and they would decide if that was the corporate 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 there something that you’re going to announce, positive or negative?

I should clarify how that works. There is a -- let’s start with the request for proposal which is I disused at that, typically the more complex, to the institutions the more complex, the bidding process becomes. Cleveland Clinic is expecting then RFPs variable in June. Actually what we’ve been able to determine there is that their [indiscernible] spend is approximately $10 million a year, which will not include their overall biologic 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 and Venture would announce.

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

No, I think we again expect to have more clinical data presented. We’re going to see in our 8-K that we recently completed the study at Hospital for Special Surgery that showed the OsteoSelect DBM product was equivalent to autologous bone graft which is the gold standard in the industry. That is extremely positive data for our products and we look to be able to accelerate sales with that data.

Our next question comes from the line of Bruce Jackson with Northland Securities.

Just one quick follow-up on the gross margins, I think last quarter, John you said that 70% to 75% were sort of the target range that you are 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 that, that will probably be at the high end of that range, but I wouldn’t change to range at this point in time. I think obviously leader there consistently, 73% to 75%, I think that you are okay.

And I’m showing no further questions at this time, I’d like to turn the conference back to management.

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 cautions 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 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, financing, 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 risk 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 product, 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 factor 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 1 month starting this afternoon approximately 2 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 investor section of the company’s website at www.bacterin.com. Thank you, ladies and gentlemen for joining us for today’s presentation.

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