Xtant Medical Holdings, Inc. - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

or

Commission File Number: 001-34951

XTANT MEDICAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

(406) 388-0480

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

Number of shares of common stock, $0.000001 par value, of registrant outstanding at July 31, 2020: 13,223,565.

XTANT MEDICAL HOLDINGS, INC.

FORM 10-Q

June 30, 2020

TABLE OF CONTENTS

As used in this report, references to “Xtant,” the “Company,” “we,” our,” or “us,” unless the context otherwise requires, refer to Xtant Medical Holdings, Inc., and its wholly owned subsidiaries, Xtant Medical, Inc., Bacterin International, Inc., and X-spine Systems, Inc., all of which are consolidated on Xtant’s condensed consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Our forward-looking statements include, but are not limited to, statements regarding our “expectations,” “hopes,” “beliefs,” “intentions,” or “strategies” regarding the future. In addition, any statements that refer to projections, forecasts, or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” and “would,” as well as similar expressions, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward looking. Forward-looking statements in this Form 10-Q may include, for example, statements about:

The forward-looking statements contained in this Form 10-Q are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties, or assumptions, many of which are beyond our control, which may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019 and this Form 10-Q.

Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as may be required under applicable securities laws.

PART I. FINANCIAL INFORMATION

XTANT MEDICAL HOLDINGS, INC.

Condensed Consolidated Balance Sheets

(In thousands, except number of shares and par value)

See notes to unaudited condensed consolidated financial statements.

XTANT MEDICAL HOLDINGS, INC.

Condensed Consolidated Statements of Operations

(Unaudited, in thousands, except number of shares and per share amounts)

See notes to unaudited condensed consolidated financial statements.

XTANT MEDICAL HOLDINGS, INC.

Condensed Consolidated Statements of Equity

(Unaudited, in thousands, except number of shares)

STOCKHOLDERS’ EQUITY – THREE MONTHS ENDED JUNE 30

STOCKHOLDERS’ EQUITY – SIX MONTHS ENDED JUNE 30

See notes to unaudited condensed consolidated financial statements.

XTANT MEDICAL HOLDINGS, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited, in thousands)

See notes to unaudited condensed consolidated financial statements.

Notes to Unaudited Condensed Consolidated Financial Statements

Business Description and Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of Xtant Medical Holdings, Inc. (“Xtant”), a Delaware corporation, and its wholly owned subsidiaries, Xtant Medical, Inc. (“Xtant Medical”), a Delaware corporation, Bacterin International, Inc. (“Bacterin”), a Nevada corporation, and X-spine Systems, Inc. (“X-spine”), an Ohio corporation (Xtant, Xtant Medical, Bacterin, and X-spine are jointly referred to herein as the “Company” or sometimes “we,” “our,” or “us”). All intercompany balances and transactions have been eliminated in consolidation.

Xtant is a global medical technology company focused on the design, development, and commercialization of a comprehensive portfolio of orthobiologics and spinal implant systems to facilitate spinal fusion in complex spine, deformity, and degenerative procedures.

The global novel strain of coronavirus, or COVID-19, pandemic has led to the closure of businesses, severe travel restrictions and implementation of social distancing measures. Hospitals and other medical facilities have cancelled or deferred elective procedures, diverted resources to patients suffering from infections and limited access for non-patients, including our direct and indirect sales representatives. Because of the COVID-19 pandemic, surgeons and their patients are required, or are choosing, to defer procedures in which our products otherwise would be used, and many facilities that specialize in the procedures in which our products otherwise would be used have temporarily closed or reduced operating hours. These circumstances have negatively impacted the ability of our employees, independent sales representatives and distributors to effectively market and sell our products, which has had and will likely continue to have a material adverse effect on our revenues.

The accompanying condensed consolidated balance sheet as of December 31, 2019, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. They do not include all disclosures required by generally accepted accounting principles for annual consolidated financial statements, but in the opinion of management include all adjustments, consisting only of normal recurring items, necessary for a fair presentation.

Interim results are not necessarily indicative of results that may be achieved in the future for the full year ending December 31, 2020.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, which are included in Xtant’s Annual Report on Form 10-K for the year ended December 31, 2019. The accounting policies set forth in those annual consolidated financial statements are the same as the accounting policies utilized in the preparation of these condensed consolidated financial statements, except as modified for appropriate interim consolidated financial statement presentation.

Reclassifications

Certain prior year amounts have been reclassified to conform with current year presentation.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments–Credit Losses: Measurement of Credit Losses on Financial Instruments to change the impairment model for most financial assets and certain other instruments. For trade and other receivables, held to maturity debt securities, loans, and other instruments, entities are required to use a new forward-looking “expected loss” model that generally will result in the earlier recognition of allowances for losses. The Company adopted the guidance on January 1, 2020 and recognized a cumulative effect adjustment of $47,000 to retained earnings and accounts receivable, net as a result of adoption. The Company has included the additional disclosures required by ASU 2016-13 in Note 3.

Although there are several other new accounting pronouncements issued or proposed by the FASB, which the Company has adopted or will adopt, as applicable, the Company does not believe any of these accounting pronouncements has had or will have a material impact on the Company’s consolidated financial position or operating results.

Use of Estimates

The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. Significant estimates include the carrying amount of property and equipment, goodwill and intangible assets and liabilities, valuation allowances for trade receivables, inventory and deferred income tax assets and liabilities, current and long-term right-of-use asset, evaluation of ability to continue as a going concern and estimates for the fair value of long-term debt, stock options and other equity awards upon which the Company determines stock-based compensation expense. Actual results could differ from those estimates.

Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recovered. The Company looks primarily to estimated undiscounted future cash flows in its assessment of whether or not long-lived assets are recoverable. As a result of the revenue decline related to the current global novel strain of coronavirus, or COVID-19 pandemic, the Company evaluated whether the carrying values of the long-lived assets were recoverable. Based on these evaluations, the Company determined that the long-lived assets were still recoverable. No impairments of long-lived assets were recorded for the three and six months ended June 30, 2020 and 2019.

Goodwill

Goodwill represents the excess of costs over fair value of assets of businesses acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have indefinite useful lives are not amortized. Instead, they are tested for impairment at least annually and whenever events or circumstances indicate that the carrying amount of the asset may not be recoverable. As a result of the current COVID-19 pandemic and its impact on the Company’s projected cash flows, the Company evaluated goodwill for impairment at the end of the second quarter of 2020. No impairments of goodwill were recorded for the three months and six months ended June 30, 2020 and 2019.

Net Loss Per Share

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding. Diluted net income (loss) per share is computed in a manner consistent with that of basic earnings per share while giving effect to all potentially dilutive shares of common stock outstanding during the period, which include the assumed exercise of stock options and warrants using the treasury stock method. Diluted net loss per share was the same as basic net loss per share for the three and six months ended June 30, 2020 and 2019, as shares issuable upon the exercise of stock options and warrants were anti-dilutive as a result of the net losses incurred for those periods. Dilutive earnings per share are not reported, as the effects of including 6,691,075 and 3,135,973 outstanding stock options, restricted stock units and warrants for the three and six months ended June 30, 2020 and 2019, respectively, are anti-dilutive.

Fair Value of Financial Instruments

The carrying values of financial instruments, including trade accounts receivable, accounts payable, accrued liabilities, and long-term debt, approximate their fair values based on terms and related interest rates as of June 30, 2020 and December 31, 2019.

In the United States, we generate most of our revenue from independent commissioned sales agents. We consign our orthobiologics products to hospitals and consign or loan our spinal implant sets to the independent sales agents. The spinal implant sets typically contain the instruments, disposables, and spinal implants required to complete a surgery. Consigned sets are managed by the sales agent to service hospitals that are high volume users for multiple procedures.

We ship replacement inventory to independent sales agents to replace the consigned inventory used in surgeries. Loaned sets are returned to the Company’s distribution center, replenished, and made available to sales agents for the next surgical procedure.

For each surgical procedure, the sales agent reports use of the product by the hospital and, as soon as practicable thereafter, ensures that the hospital provides a purchase order to the Company. Upon receipt of the hospital purchase order, the Company invoices the hospital, and revenue is recognized in the proper period. Additionally, the Company sells product directly to domestic and international stocking resellers and private label resellers. Upon receipt and acceptance of a purchase order from a stocking reseller, the Company ships product and invoices the reseller. The Company recognizes revenue when control of the promised goods is transferred to the customer, in an amount that reflects the consideration we expect to collect in exchange for those goods or services. There is generally no customer acceptance or other condition that prevents the Company from recognizing revenue in accordance with the delivery terms for these sales transactions.

The Company operates in one reportable segment with our net revenue derived primarily from the sale of orthobiologics and spinal implant products across North America, Europe, Asia Pacific, and Latin America. Sales are reported net of returns. The following table presents revenues from these product lines for the three and six months ended June 30, 2020 and 2019 (in thousands):

Concurrent with the adoption of ASU 2016-13, the Company’s allowance for doubtful accounts was expanded to include provision for current expected credit loss (“CECL”). The Company’s provision for CECL is determined based on historical collection experience adjusted for current economic conditions affecting collectability. Actual customer collections could differ from estimates. Account balances are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Provisions to the allowance for credit losses are charged to expense. Activity within the allowance for credit losses was as follows for the three months ended June 30, 2020 (in thousands):

Inventories consist of the following (in thousands):

Property and equipment, net are as follows (in thousands):

The Company leases certain equipment under finance leases. For financial reporting purposes, minimum lease payments relating to the assets have been capitalized. As of June 30, 2020, the Company has recorded $1.4 million of gross assets in equipment and $1.1 million of accumulated depreciation for assets subject to finance leases.

The following table sets forth information regarding intangible assets (in thousands):

Accrued liabilities consist of the following (in thousands):

The Company has a credit facility with OrbiMed Royalty Opportunities II, LP (“Royalty Opportunities”) and ROS Acquisition Offshore LP (“ROS” and together with Royalty Opportunities the “Lenders”) (the “Second Amended and Restated Credit Agreement”). On May 6, 2020, the Company, entered into a First Amendment to the Second Amended and Restated Credit Agreement (the “First Amendment”) with the Lenders, which among other things, provided that:

On May 6, 2020, Xtant issued warrants to purchase an aggregate of 2.4 million shares of Company common stock to the Lenders, with an exercise price of $0.01 per share and an expiration date of May 6, 2030 (collectively, the “2020 Warrants”). The issuance of the 2020 Warrants was a condition to the effectiveness of the First Amendment. The First Amendment was accounted for as a debt modification whereby the recorded debt balance was discounted for the fair value of the 2020 Warrants issued and interest expense is accrued through the maturity date of the Loans at the post-amendment effective interest rate of 10.02%. The premium recorded as of June 30, 2020 will continue to increase until the Company makes cash interest payments beginning December 31, 2020.

As of June 30, 2020, the Company had availability for additional delayed draw loan advances of $2.2 million, subject to Lenders’ discretion. In addition, the Company may request additional term loans from the Lenders in an aggregate amount up to $10.0 million, subject to Lenders’ discretion.

Long-term debt consists of the following (in thousands):

The Lenders, which collectively own approximately 70% of the Company’s outstanding common stock, and beneficially own, with their warrants, approximately 78% of the Company’s common stock, are the sole holders of the Company’s outstanding long-term debt. In addition, as described in more detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission (the “SEC”) on March 5, 2020, the Company is a party to an Investor Rights Agreement and Registration Rights Agreement with the Lenders in addition to the Second Amended and Restated Credit Agreement.

Stock option activity, including options granted under the Xtant Medical Holdings, Inc. 2018 Equity Incentive Plan, as amended (the “2018 Plan”), and the Amended and Restated Xtant Medical Equity Incentive Plan and options granted to new hires to purchase shares of our common stock outside of any stockholder-approved plan, was as follows for the six months ended:

During the six months ended June 30, 2020, 489,437 restricted stock units were granted under the 2018 Plan, which vest over a weighted average period of 1.5 years. Total restricted stock units outstanding under the 2018 Plan were 927,548 and 40,000 as of June 30, 2020 and 2019, respectively.

2020 Warrants

As noted in Note 8, on May 6, 2020, the Company issued the 2020 Warrants. The fair value of the 2020 Warrants upon issuance was determined to be $1.9 million. The 2020 Warrants meet all the requirements to be classified as equity awards in accordance with Accounting Standards Codification (“ASC”) No. 815-40. The number of shares of Company common stock issuable upon exercise of the 2020 Warrants is subject to standard and customary anti-dilution provisions for stock splits, stock dividends, or similar transactions.

2019 Warrants

On April 1, 2019, the Company issued warrants to purchase an aggregate of 1.2 million shares of Company common stock to the Lenders with an exercise price of $0.01 per share and an expiration date of April 1, 2029. The issuance of the 2019 Warrants was a condition to the effectiveness of the Second Amended and Restated Credit Agreement. The fair value of the 2019 Warrants upon issuance was determined to be $9 thousand. The 2019 Warrants meet all the requirements to be classified as equity awards in accordance with ASC No. 815-40. The number of shares of Company common stock issuable upon exercise of the 2019 Warrants is subject to standard and customary anti-dilution provisions for stock splits, stock dividends, or similar transactions.

The estimated fair value of warrants issued was derived using a valuation model with the following weighted-average assumptions:

Operating Leases

We lease three office facilities as of June 30, 2020 in Belgrade, Montana under non-cancelable operating lease agreements with expiration dates between 2023 and 2025. We have the option to extend certain leases to five or ten-year term(s), and we have the right of first refusal on any sale.

Present Value of Long-term Leases

As of June 30, 2020, the weighted-average remaining lease term was 4.4 years. The Company’s lease agreements do not provide a readily determinable implicit rate nor is it available to the Company from its lessors. Instead, as of June 30, 2020, the Company estimates the weighted-average discount rate for its operating leases to be 5.2% of present value based on the incremental borrowing rate.

Future minimum payments for the next five years and thereafter as of June 30, 2020 under these long-term operating leases are as follows (in thousands):

Rent expense was $0.1 million for the three months ended June 30, 2020 and 2019 and $0.3 million for the six months ended June 30, 2020 and 2019. We have no contingent rent agreements.

Financing Leases

Future minimum payments under finance leases are as follows as of June 30, 2020 (in thousands):

Litigation

On December 13, 2018, a complaint was filed by RSB Spine, LLC against Xtant Medical Holdings, Inc., which claimed that some of our products, including the Irix-A Lumbar Integrated Fusion System and the Irix-C Cervical Integrated Fusion System, infringe certain of RSB Spine’s patents. On February 28, 2020, we entered into a confidential settlement and patent license agreement with RSB Spine pursuant to which we agreed to make an undisclosed settlement payment to RSB Spine and pay royalties on future sales of the two products through the expiration of the asserted patents. The settlement payment was included in accrued expenses as of December 31, 2019.

In addition, we are subject to potential liabilities under government regulations and various claims and legal actions that are pending or may be asserted from time to time. These matters arise in the ordinary course and conduct of our business and may include, for example, commercial, product liability, intellectual property, and employment matters. We intend to continue to defend the Company vigorously in such matters and, when warranted, take legal action against others. Furthermore, we regularly assess contingencies to determine the degree of probability and range of possible loss for potential accrual in our financial statements. An estimated loss contingency is accrued in our financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Based on our assessment, we have adequately accrued an amount for contingent liabilities currently in existence. We do not accrue amounts for liabilities that we do not believe are probable or that we consider immaterial to our overall financial position. Litigation is inherently unpredictable, and unfavorable resolutions could occur. As a result, assessing contingencies is highly subjective and requires judgment about future events. The amount of ultimate loss may exceed the Company’s current accruals, and it is possible that its cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.

Indemnifications

Our indemnification arrangements generally include limited warranties and certain provisions for indemnifying customers against liabilities if our products or services infringe a third-party’s intellectual property rights. To date, we have not incurred any material costs as a result of such warranties or indemnification provisions and have not accrued any liabilities related to such obligations in the accompanying condensed consolidated financial statements.

We have also agreed to indemnify our directors and executive officers for costs associated with any fees, expenses, judgments, fines, and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person’s service as a director or officer, including any action by us, arising out of that person’s services as our director or officer or that person’s services provided to any other company or enterprise at our request.

In evaluating the realizability of the net deferred tax assets, we take into account a number of factors, primarily relating to the ability to generate taxable income. Where it is determined that it is likely that we will be unable to realize deferred tax assets, a valuation allowance is established against the portion of the deferred tax asset. Because it cannot be accurately determined when or if we will become profitable, a valuation allowance was provided against the entire deferred income tax asset balance.

The Company did not recognize any interest or penalties related to income taxes for the three and six months ended June 30, 2020 and 2019.

Supplemental cash flow information is as follows (in thousands):

Royalty Opportunities and ROS collectively own approximately 70% of the Company’s outstanding common stock and are the sole holders of our outstanding long-term debt and are Lenders under the Second A&R Credit Agreement. In addition, as described in more detail under Note 1, “Business Description and Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, we are party to an Investor Rights Agreement and Registration Rights Agreement with Royalty Opportunities and ROS. Transactions between the Company, on the one hand, and Royalty Opportunities and ROS, on the other hand, are conducted under the provisions of the Second Amended and Restated Credit Agreement, the Company’s prior Credit Agreement, the Investor Rights Agreement, and the Registration Rights Agreement, as previously noted.

On January 22, 2020, the Company amended its Sublease Agreement with Cardialen, Inc., reducing monthly rent to $1,350 per month. Because Jeffrey Peters is both a member of our Board and the Chief Executive Officer, President, and a Director of Cardialen, this transaction qualifies as a related party transaction.

All related party transactions are reviewed and approved by the Audit Committee or the disinterested members of the full Board.

The Company’s management reviews financial results and manages the business on an aggregate basis. Therefore, financial results are reported in a single operating segment: the development, manufacture, and marketing of orthopedic medical products and devices.

The Company attributes revenues to geographic areas based on the location of the customer. Approximately 98% and 96% of sales were in the United States for the three months ended June 30, 2020 and 2019, respectively, and 97% and 96% for the six months ended June 30, 2020 and 2019, respectively. Total revenue by major geographic area is as follows (in thousands):

This Management’s Discussion and Analysis provides material historical and prospective disclosures intended to enable investors and other users to assess our financial condition and results of operations. The following discussion should be read in conjunction with our condensed consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and accompanying notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Some of the numbers included herein have been rounded for the convenience of presentation. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed above in “Cautionary Statement Regarding Forward-Looking Statements” and elsewhere in this Form 10-Q.

Executive Summary

We develop, manufacture, and market regenerative medicine products and medical devices for domestic and international markets. Our products serve the specialized needs of orthopedic and neurological surgeons, including orthobiologics for the promotion of bone healing, implants, and instrumentation for the treatment of spinal disease. We promote our products in the United States largely through independent distributors and stocking agents, augmented by direct employees.

As of June 30, 2020, our cash and cash equivalents were $3.0 million. On March 29, 2019, we entered into a Second Amended and Restated Credit Agreement (“Second Amended and Restated Credit Agreement”), which amended and restated our prior credit agreement, as amended (“Prior Credit Agreement”), revised certain covenants and increased our credit availability by $10.0 million, subject to the discretion of our lenders. On May 6, 2020, we entered into a First Amendment to the Second Amended and Restated Credit Agreement (“First Amendment”), which amended the Second Amended and Restated Credit Agreement to extend the period over which interest does not accrue, extend the maturity and revise certain covenants. As of June 30, 2020, we had availability of $12.2 million under our credit facility, subject to the discretion of our lenders. We believe that cash and cash equivalents, together with the availability under the Second Amended and Restated Credit Agreement, will be sufficient to meet our anticipated cash requirements for at least the next 12 months.

On April 4, 2019, we received a letter from NYSE Regulation notifying us that we are not in compliance with the NYSE American’s continued listing standards relating to stockholders’ equity. Specifically, we are not in compliance with Section 1003(a)(i) of the NYSE American Company Guide (“Company Guide”) with stockholders’ equity of less than $2.0 million and net losses in two of the three most recent fiscal years, Section 1003(a)(ii) with stockholders’ equity of less than $4.0 million and net losses in three of the four most recent fiscal years, and Section 1003(a)(iii) with stockholders’ equity of less than $6.0 million and net losses in the five most recent fiscal years. Therefore, we became subject to the procedures and requirements of Section 1009 of the Company Guide. On May 3, 2019, we submitted a plan of compliance to NYSE Regulation addressing how we intend to regain compliance with Sections 1003(a)(i), 1003(a)(ii), and 1003(a)(iii) or meet the exemption in Section 1003(a) of the Company Guide by October 4, 2020. On May 23, 2019, we received a letter from NYSE Regulation stating that the Company’s plan of compliance has been accepted and the Company has been granted a plan period through October 4, 2020. We have been advised that we will be subject to delisting proceedings if we do not regain compliance prior to October 4, 2020 or if NYSE Regulation determines that we are not making progress consistent with our plan of compliance. Our common stock will continue to trade on the NYSE American under the symbol “XTNT,” with the added designation of “.BC” to indicate that we are not in compliance with the continued listing standards.

Impact of the COVID-19 Pandemic

The global COVID-19 pandemic has led to the closure of businesses, severe travel restrictions and the implementation of social distancing measures. Hospitals and other medical facilities have canceled or deferred elective surgeries, reduced and diverted staffing and diverted resources to patients suffering from infections and limited access for non-patients, including our direct and indirect sales representatives. Because of the COVID-19 pandemic, surgeons and their patients are required, or are choosing, to defer procedures in which our products otherwise would be used, and many facilities that specialize in the procedures in which our products otherwise would be used have closed or reduced operating hours. These circumstances have negatively impacted the ability of our employees, independent sales representatives and distributors to effectively market and sell our products, which has had a material adverse effect on our revenues and despite the recent easing of such restrictions in many locations will likely continue to have a material adverse effect on our revenues. In addition, even after the easing of such restrictions such that governmental orders no longer prohibit or recommend against performing such procedures, patients may continue to defer such procedures out of concern of being exposed to coronavirus or for other reasons.

The COVID-19 pandemic has also caused adverse effects on general commercial activity and the global economy, which has led to an economic slowdown and recession and could cause other unpredictable events, each of which could adversely affect our business, operating results or financial condition. The adverse effect of the pandemic on the broader economy also will likely negatively affect demand for procedures using our products, both in the near- and long-term, and could cause one or more of our distributors, independent sales representatives, customers, contract manufacturers and suppliers to experience financial distress, cancel, postpone or delay orders, be unable to perform under a contract, file for bankruptcy protection, go out of business, or suffer disruptions in their business. This could impact our ability to manufacture and provide products and otherwise operate our business, as well as increase our costs and expenses.

The anticipated decline in our revenues and adverse impact on our other operating results could impact our debt covenants under our credit facility and our ability to access funding thereunder. We may need to borrow funds from alternative sources, such as other lenders and institutions or government agencies. There can be no guarantee that such borrowing will be available or available on favorable terms or without restrictions that may otherwise impair our operating flexibility. The COVID-19 pandemic has also led to and could continue to lead to severe disruption and volatility in the global capital markets, which could increase our cost of future capital and adversely affect our ability to access the capital markets in the future.

In response to the COVID-19 pandemic, during the second quarter of 2020, we implemented a series of cost-savings actions intended to preserve capital to support our operations. These temporary cost-saving actions included:

Effective July 1, 2020, we terminated the temporary 20% base salary and wage reductions and reinstituted the full base salaries and wages of all our employees.

COVID-19 has resulted and will likely continue to result in a material adverse effect on our business, operating results, financial condition, prospects and the trading price of our common stock in the near-term and beyond 2020. The full extent to which the COVID-19 pandemic will impact our business will depend on future developments that are highly uncertain and cannot be accurately predicted, including new information that may emerge concerning COVID-19 and the actions to contain it or treat its impact.

Results of Operations

Comparison of Three and Six Months Ended June 30, 2020 and June 30, 2019

Revenue

Total revenue for the three and six months ended June 30, 2020 was $10.5 million and $25.3 million, respectively, which represents a decrease of 31.1% and 20.9%, respectively, compared to $15.3 million and $32.0 million for the three and six months ended June 30, 2019, respectively. The decrease in revenue is largely attributed to the impact of COVID-19 and the sudden drop in elective procedures beginning in early March 2020 as a result of the COVID-19 pandemic.

Cost of Sales and Gross Profit

Cost of sales consists primarily of manufacturing and product purchase costs as well as depreciation of surgical trays. Cost of sales also includes reserves for estimated excess inventory, inventory on consignment that may be missing and not returned, and reserves for estimated missing and damaged consigned surgical instruments. Cost of sales decreased by 25.8%, or $1.4 million, to $4.0 million for the three months ended June 30, 2020 from $5.4 million for the three months ended June 30, 2019. Cost of sales decreased by 18.9%, or $2.1 million, to $9.1 million for the six months ended June 30, 2020 from $11.3 million for the six months ended June 30, 2019. The reduction in cost of sales is primarily due to lower revenue during the three and six months ended June 30, 2020 versus the comparable periods in 2019, as mentioned above.

Gross profit as a percentage of sales decreased to 62.2% for the three months ended June 30, 2020 compared to 64.9% for the same period in 2019. Gross profit as a percentage of sales decreased to 63.9% for the six months ended June 30, 2020 compared to 64.8% for the same period in 2019. The reductions during the three and six months ended June 30, 2020 compared to the same period in the prior year are primarily attributable to diminished economies of scale.

General and Administrative

General and administrative expenses consist principally of personnel costs for corporate employees, cash-based and stock-based compensation related costs, and corporate expenses for legal, accounting, professional fees, and occupancy costs. General and administrative expenses decreased 30.0%, or $1.3 million, to $2.9 million for the three months ended June 30, 2020, compared to $4.2 million for the same period in 2019. General and administrative expenses decreased 16.3%, or $1.4 million, to $7.3 million for the six months ended June 30, 2020, compared to $8.7 million for the same period in 2019. The decrease for the three-month comparison is primarily attributable to lower legal and consulting fees of $0.6 million, reduced executive recruiting fees of $0.4 million, reduced legal settlement expenses of $0.3 million, and reduced salaries and wages of $0.3 million during the three months ended June 30, 2020. This decrease was offset partially by additional stock-based compensation expense of $0.2 million during the three months ended June 30, 2020. The decrease for the six-month comparison is primarily attributable to lower legal and consulting fees of $1.1 million, reduced legal settlement expenses of $0.8 million, reduced executive recruiting fees of $0.4 million, reduced salaries and wages of $0.2 million, and reduced license fees of $0.2 million during the six months ended June 30, 2020. This decrease was offset partially by severance expense of $0.8 million and additional stock-based compensation expense of $0.3 million during the six months ended June 30, 2020. The reduced salaries and wages were due to the reduction in headcount and the temporary 20% salary and wage decreases implemented during the second quarter of 2020 in response to the COVID-19 pandemic.

Sales and Marketing

Sales and marketing expenses consist primarily of sales commissions, personnel costs for sales and marketing employees, costs for trade shows, sales conventions and meetings, travel expenses, advertising, and other sales and marketing related costs. Sales and marketing expenses decreased 35.9%, or $2.2 million, to $3.9 million for the three months ended June 30, 2020, compared to $6.1 million for the same period of 2019. Sales and marketing expenses decreased 19.5%, or $2.5 million, to $10.3 million for the six months ended June 30, 2020, compared to $12.8 million for the same period of 2019. The decrease for the three-month comparison is primarily due to the reduction in sales commissions of $1.5 million due to lower revenues versus the comparable period in 2019 and reduced salaries and wages of $0.4 million due to the reduction in headcount and the temporary 20% salary and wage decreases implemented during the second quarter of 2020 in response to the COVID-19 pandemic. The decrease for the six-month comparison is primarily due to the reduction in sales commissions of $1.9 million due to lower revenues versus the comparable period in 2019 and reduced salaries and wages of $0.4 million.

Research and Development

Research and development expenses consist primarily of internal costs for the development of new technologies and processes. Research and development expenses decreased 47.1%, or $0.1 million, to $0.1 million for the three months ended June 30, 2020, compared to $0.2 million for the three months ended June 30, 2019. Research and development expenses decreased 25.2%, or $0.1 million, to $0.4 million for the six months ended June 30, 2020, compared to $0.5 million for the six months ended June 30, 2019. The reduction in research and development expenses is primarily due to reduced salaries and wages during the three and six months ended June 30, 2020 compared to the prior year periods.

Interest Expense

Interest expense is related to interest incurred from our debt instruments. Interest expense was $2.1 million for the three months ended June 30, 2020 compared to $1.3 million for the three months ended June 30, 2020. Interest expense was $3.2 million for the six months ended June 30, 2020 and $3.3 million for the six months ended June 30, 2019. The increase in interest expense during the three months ended June 30, 2020 resulted from additional interest associated with the First Amendment. Interest expense during the six months ended June 30, 2020 was comparable to the prior year period.

Liquidity and Capital Resources

Working Capital

Since our inception, we have financed our operations through operating cash flows, the private placement of equity securities and convertible debt, an equity credit facility, a debt facility, a common stock rights offering, and other debt transactions.

Cash Flows

Net cash used in operating activities for the first six months of 2020 was $1.6 million attributed to the increase in inventories of $4.2 million and the reduction of accrued liabilities of $0.7 million, offset partially by the decrease in accounts receivable of $2.3 million and increase in accounts payable of $0.9 million. For the comparable period of 2019, net cash provided by operating activities was $1.0 million.

Net cash used in investing activities for the first six months of 2020 and 2019 was $0.6 million and $48 thousand, respectively, primarily representing purchases of property and equipment.

Net cash used in financing activities was $0.1 million and $0.4 million for the first six months of 2020 and 2019, respectively, primarily representing payments for financing leases.

Credit Facility

On March 29, 2019, we entered into the Second Amended and Restated Credit Agreement with the Lenders, which amended and restated the Prior Credit Agreement. The Second Amended and Restated Credit Agreement amended the Prior Credit Agreement to provide that we may request term loans from the Lenders in their sole discretion in an amount equal to the remaining availability for additional delayed draw loans, which was approximately $2.2 million as of the date of the Second Amended and Restated Credit Agreement, and request additional term loans from the Lenders in their sole discretion in an aggregate amount of up to $10.0 million, the amount of each loan draw to be also subject to our production of a thirteen-week cash flow forecast that is approved by the Lenders and which shows a projected cash balance for the following two-week period of less than $1.5 million, as well as the satisfaction (or waiver in writing by each Lender) of conditions precedent, including closing certificate, delivery of a budget, and other satisfactory documents. In addition, the Second Amended and Restated Credit Agreement provides that (i) no interest will accrue on the loans thereunder from and after January 1, 2019 until March 31, 2020; (ii) beginning April 1, 2020, through the maturity date of the Second Amended and Restated Credit Agreement, interest payable in cash will accrue on the loans thereunder at a rate per annum equal to the sum of (a) 10.00% plus (b) the higher of (x) the LIBO Rate (as such term is defined in the Second Amended and Restated Credit Agreement) and (y) 2.3125%; (iii) the maturity date of the loans thereunder is March 31, 2021; (iv) the Consolidated Senior Leverage Ratio and Consolidated EBITDA (as such terms were defined in the Prior Credit Agreement) financial covenants were deleted and a new Revenue Base (as such term is defined in the Second Amended and Restated Credit Agreement) financial covenant was added; and (v) the key person event default provision was revised to refer specifically to certain then recently-hired executive officers of the Company.

On May 6, 2020, we entered into a First Amendment to the Second Amended and Restated Credit Agreement with the Lenders, which amended the Second Amended and Restated Credit Agreement. Under the terms of the First Amendment, the Second Amended and Restated Credit Agreement was amended to provide that:

As of June 30, 2020, we were in compliance with all covenants under the Second Amended and Restated Credit Agreement, as amended by the First Amendment.

Cash Requirements

We believe that our June 30, 2020 cash and cash equivalents of $3.0 million, together with the availability of $12.2 million under the Second Amended and Restated Credit Agreement as of such date, will be sufficient to meet our anticipated cash requirements for at least the next 12 months. However, we may require additional funds to fund our future operations and business strategy. Accordingly, there is no assurance that we will not need or seek additional funding prior to such time. We may elect to raise additional funds even before we need them if market conditions for raising additional capital are favorable. We may seek to raise additional funds through various sources, such as equity and debt financings, additional debt restructurings or refinancings, or through strategic collaborations and license agreements. We can give no assurances that we will be able to secure additional sources of funds to support our operations, or if such funds are available to us, that such additional financing will be sufficient to meet our needs or on terms acceptable to us. This is particularly true if economic and market conditions deteriorate.

To the extent that we raise additional capital through the sale of equity or convertible debt securities or the restructuring or refinancing of our debt, the interests of our current stockholders may be diluted, and the terms may include liquidation or other preferences that adversely affect the rights of our current stockholders. If we issue preferred stock, it could affect the rights of our stockholders or reduce the value of our common stock. In particular, specific rights granted to future holders of preferred stock may include voting rights, preferences as to dividends and liquidation, conversion and redemption rights, sinking fund provisions, and restrictions on our ability to merge with or sell our assets to a third party. Additional debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures, or declaring dividends. Prior to raising additional equity or debt financing, we must obtain the consent of the Lenders, and no assurance can be provided that the Lenders would provide such consent, which could limit our ability to raise additional financing.

Off Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures, or capital resources that are material to an investor in our common stock.

Critical Accounting Estimates

Management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions for the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and any such differences may be material.

There have been no changes in our critical accounting estimates for the three and six months ended June 30, 2020 as compared to the critical accounting estimates described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 other than for adoption of ASU 2016-13 as described in Note 1 and Note 3 to our condensed consolidated financial statements.

As a smaller reporting company, we are not required to provide the information required by this Item.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act as of June 30, 2020. Based upon that evaluation, our principal executive officer and principal financial officer concluded that as of June 30, 2020, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

We are subject to potential liabilities under government regulations and various claims and legal actions that are pending or may be asserted from time to time. These matters arise in the ordinary course and conduct of our business and may include, for example, commercial, product liability, intellectual property, and employment matters. We intend to continue to defend the Company vigorously in such matters and when warranted, take legal action against others.

Although Item 1A is inapplicable to Xtant as a smaller reporting company, we hereby disclose the following additional risk:

The Company’s business, operating results and financial condition have been and will likely continue to be materially adversely affected by the global novel strain of coronavirus (COVID-19) pandemic.

The global COVID-19 pandemic has led to the closure of businesses, severe travel restrictions and social distancing. Hospitals and other medical facilities have canceled elective surgeries, reduced and diverted staffing and diverted resources to patients suffering from the infectious disease and limited hospital access for non-patients, including our direct and indirect sales representatives. Because of the COVID-19 pandemic, surgeons and their patients are required, or are choosing, to defer procedures in which our products otherwise would be used, and many facilities that specialize in the procedures in which our products otherwise would be used have closed or reduced operating hours. These circumstances have negatively impacted the ability of our employees, independent sales representatives and distributors to effectively market and sell our products, which has had and will likely continue to have a material adverse effect on our revenues. In addition, even after the pandemic has subsided and/or governmental orders no longer prohibit or recommend against performing such procedures, patients may continue to defer such procedures out of concern of being exposed to coronavirus or for other reasons.

The COVID-19 pandemic has also caused adverse effects on general commercial activity and the global economy, which has led to an economic slowdown and recession and could cause other unpredictable events, each of which could adversely affect our business, operating results or financial condition. The adverse effect of the pandemic on the broader economy also will likely negatively affect demand for procedures using our products, both in the near- and long-term. In addition, as a result of this negative effect on our economy, one or more of our distributors, independent sales representatives, customers, contract manufacturers and suppliers may experience financial distress, cancel, postpone or delay orders, be unable to perform under a contract, file for bankruptcy protection, go out of business, or suffer disruptions in their business or we may need to offer special payment terms or relief to our distributors, independent sales representatives and customers. Accordingly, we believe we will be exposed to heightened credit risk as a result of the pandemic. This could adversely impact our ability to manufacture and provide products and otherwise operate our business, as well as increase our costs and expenses.

The anticipated decline in our revenues and adverse impact on our other operating results could impact our debt covenants under our credit facility and our ability to access funding thereunder. We may need to borrow funds from alternative sources, such as other lenders and institutions or government agencies. There can be no guarantee that such borrowing will be available or available on favorable terms or without restrictions that may otherwise impair our operating flexibility. The COVID-19 pandemic has also led to and could continue to lead to severe disruption and volatility in the global capital markets, which could increase our cost of future capital and adversely affect our ability to access the capital markets in the future.

The foregoing and other continued disruptions to our business as a result of COVID-19 have resulted and could continue to result in a material adverse effect on our business, operating results, financial condition, prospects and the trading price of our common stock in the near-term and beyond 2020. The full extent to which the COVID-19 pandemic will impact our business will depend on future developments that are highly uncertain and cannot be accurately predicted, including new information that may emerge concerning COVID-19 and the actions to contain it or treat its impact. The COVID-19 pandemic also heightens the risks in certain of the other risk factors described in our Annual Report Form 10-K for the year ended December 31, 2019.

Not applicable.

Not applicable.

Not applicable.

2020 Bonus Plan

On July 29, 2020, the Board of Directors of the Company (the “Board”), upon recommendation of the Compensation Committee, formally approved the material terms of a discretionary bonus plan for 2020 applicable to the Company’s executive officers and certain other participants, which annual bonuses are tied closely to the Company’s financial performance for the fiscal year ended December 31, 2020 (the “2020 Bonus Plan”). Under the 2020 Bonus Plan, each participant will be eligible to earn a discretionary annual bonus based on the Company’s achievement in 2020 of performance goals relating to total revenue, adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, as adjusted for certain non-recurring items), certain predefined individual goals and Board discretion. The performance goals will be weighted as follows for the Company’s executive officers:

The table below sets forth the target annual bonus opportunity, expressed as a percentage of annual base salary, for each executive.

The determination of bonuses under the 2020 Bonus Plan will be in the sole discretion of the Board or the Compensation Committee and, unless otherwise agreed upon by the Company in writing, will only be paid to a participant if he or she remains an employee of the Company or one of its subsidiaries on the payment date, which payment date will be determined by the Board or the Compensation Committee at a later date and is contemplated to be after the issuance of the Company’s financial statements for 2020.

Reinstatement of Executive Officer Base Salaries

In response to the COVID-19 pandemic, during the second quarter of 2020, the Company implemented a series of cost-savings actions intended to preserve capital to support our operations, including the institution of a temporary 20% base salary reduction for all executive officers. On July 27, 2020, the Board, upon recommendation of the Compensation Committee, approved the termination of the 20% temporary base salary reductions and the reinstatement of full base salaries for all executive officers, retroactive to July 1, 2020.

2020 Annual Meeting of Stockholders

On July 29, 2020, the Board established Tuesday, October 27, 2020 as the date of the Company’s 2020 annual meeting of stockholders (the “2020 Annual Meeting”). Although it is anticipated that the 2020 Annual Meeting will be held at 9:00 a.m., local time, at the offices of Fox Rothschild LLP in New York City, the exact time and location of the 2020 Annual Meeting will be specified in the Company’s proxy statement for the 2020 Annual Meeting.

The following exhibits are being filed or furnished with this Quarterly Report on Form 10-Q:

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.