atec-10k_20161231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

Form 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to

Commission file number: 000-52024

 

ALPHATEC HOLDINGS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

 

20-2463898

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

5818 El Camino Real, Carlsbad,

California

 

92008

(Address of Principal Executive Offices)

 

(Zip Code)

(760) 431-9286

(Registrant’s Telephone Number, Including Area Code)

 

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

 

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, par value $0.0001 per share

 

The NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Exchange Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.    Yes      No  

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      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

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

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

(Do not check if a smaller reporting company)

Smaller reporting company

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) computed by reference to the price at which the common stock was last sold as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2016), was approximately $24.7 million.

The number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, as of March 24, 2017 was 9,048,145.

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

 


ALPHATEC HOLDINGS, INC.

FORM 10-K—ANNUAL REPORT

For the Fiscal Year Ended December 31, 2016

Table of Contents

 

 

 

 

Page

PART I

 

 

 

Item 1.

 

Business

1

Item 1A.

 

Risk Factors

16

Item 1B.

 

Unresolved Staff Comments

36

Item 2.

 

Properties

36

Item 3.

 

Legal Proceedings

37

Item 4.

 

Mine Safety Disclosures

37

 

 

 

 

PART II

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

38

Item 6.

 

Selected Financial Data

39

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

40

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

55

Item 8.

 

Financial Statements and Supplementary Data

55

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

55

Item 9A.

 

Controls and Procedures

55

Item 9B.

 

Other Information

56

 

 

 

 

PART III

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

57

Item 11.

 

Executive Compensation

57

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

57

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

57

Item 14.

 

Principal Accounting Fees and Services

57

 

 

 

 

PART IV

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

58

 

In this Annual Report on Form 10-K, the terms “we,” “us,” “our,” “Alphatec Holdings” and “Alphatec” mean Alphatec Holdings, Inc. and our subsidiaries and their subsidiaries. “Alphatec Spine” refers to our wholly-owned operating subsidiary Alphatec Spine, Inc. “Scient’x” refers to our operating affiliate, Scient’x S.A.S., which is wholly-owned by several of our subsidiaries, and Scient’x’s subsidiaries.

 

 

 


PART I

Item 1.

Business

Overview

We are a medical technology company focused on the design, development and promotion of products for the surgical treatment of spinal disorders. Our mission is to improve patient lives by delivering advancements in spinal fusion technologies. We have a comprehensive product and procedural portfolio, as well as a pipeline that addresses the cervical, thoracolumbar and intervertebral regions of the spine and covers a variety of spinal disorders from degenerative disease to complex deformity and trauma. Our principal product offerings are focused on the U.S. market for fusion-based spinal disorder solutions. We believe that our products and procedural offerings are attractive to surgeons, hospitals, and patients due to innovative features and benefits that are designed to streamline surgical procedures, improve patient outcomes, while delivering predicable results at lower costs.

Recent Developments

On September 1, 2016, we completed the sale of our international distribution operations and agreements, including our wholly-owned subsidiaries in Japan, Brazil, Australia, China and Singapore and substantially all of the assets of our other sales operations in the United Kingdom and Italy, or collectively the International Business, to an affiliate of Globus. Following the closing of the Globus Transaction, we now operate in the U.S. market only.

 

Between September 1, 2016 and March 24, 2017, we announced several changes to our senior leadership team, including the appointment of Terry Rich as our Chief Executive Officer; Craig Hunsaker as our Executive Vice President, People and Culture and General Counsel; Jon Allen as our Executive Vice President, Commercial Operations; Brian Snider as our Executive Vice President, Strategic Marketing and Product Development; and Jeff Black as our Executive Vice President, Chief Financial Officer.

 

On March 29, 2017, we completed a Private Placement of our  securities to certain institutional and accredited investors, including certain directors and executive officers of the Company, providing for the sale by the Company of 1,809,628 shares of our common stock at a purchase price of $2.00 per share, 15,245 shares of newly designated Series A Convertible Preferred Stock (the “Series A Convertible Preferred Stock”) at a purchase price of $1,000 per share (which Preferred Shares are convertible into approximately 7,622,372 shares of our common stock, subject to limitations on conversion until the approval by our stockholders as required in accordance with the NASDAQ Global Select Market rules), and warrants to purchase up to 9,432,000 shares of our Common Stock at an exercise price of $2.00 per share (the “Warrants”), in a private placement (the “Private Placement”). The Warrants will become exercisable following stockholder approval, are subject to certain ownership limitations, and expire five years after the date of such Stockholder approval. The aggregate gross proceeds for the Private Placement were approximately $18.9 million. We intend to use the net proceeds from the Private Placement for general corporate and working capital purposes.

Strategy

Our goal is to build a high-growth organization focused on innovation and value delivery.  By working with world class surgeons to simplify procedures and deliver better outcomes, we believe that we will be positioned to take a greater share of the U.S. spine market, becoming the partner of choice for spine surgeons, hospitals, healthcare systems and payors.

To achieve our vision, we are committed to attracting, engaging and retaining the best talent in the industry, and investing in the following “vital few” strategies:

U.S. Commercial Execution and Growth – Dedicated and Loyal Sales Channel

Currently, we market and sell our products in the U.S. through a network of non-exclusive independent distributors and direct sales representatives. Our goal is to deliver consistent, predictable growth through a durable brand commitment.  To accomplish this, we believe there is significant opportunity for us to partner closely with distributors to create a more dedicated and loyal sales channel for the future.  We are eliminating our stocking distributors and are moving our existing distributor relationships to more dedicated and non-competitive partnerships.  As part of this strategy we intend to add new, high-quality distributors to enable future growth.  We believe this will allow us to reach an untapped market of surgeons, hospitals and national accounts across the U.S., as well as further penetrate existing accounts and territories. We feel that the recent consolidation in the industry has afforded us the opportunity to partner with large, seasoned distributors that are looking to re-enter the spine market with our robust product portfolio that is solely focused in spine solutions.

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We also employ a national accounts team that is responsible for securing access at hospitals and group purchasing organizations, or GPOs, across the U.S. We have had strong success with securing access to hospitals and GPOs and today much of our business is achieved through these accounts.  We believe that this access is a key differentiator for us.  We will continue to focus our efforts and investment in developing and maintaining relationships with key GPOs and hospital networks to secure favorable contracts and develop strategies to convert or grow business within existing accounts.    

As part of this effort we are also significantly enhancing our specialized sales training and education programs for independent distributors and direct sales representatives to enhance overall sales productivity.

Reduce Costs and Drive Fiscal Responsibility Across the Organization – Financial Health and Wellness

We plan to embed fiscal responsibility throughout our culture with the goal of remaining disciplined to sustainable standards and accountability at every level of planning and execution throughout the organization.  We are evaluating our existing processes in order to drive efficiency throughout the organization.  We will actively manage our cash and will work to ensure that all cash across the business is deployed with the goal of increasing free cash flow.  We are also striving to drive additional revenue by focusing our capital spend towards making strategic investments in commercializing our new products.  

Product Innovation Focus and Position in Spine

We are dedicated to the development, launch and promotion of innovative products that simplify procedures for surgeons and improve patient outcomes. We support these products through comprehensive sales force and surgeon training and technical support. Our short-term and long-term pipeline is designed to offer us increased revenue opportunities by addressing the core market segments of spinal fusion, including both open and minimally invasive surgical, or MIS, pedicle screw systems, interbody devices, cervical plates and a comprehensive biologics offering.

We are focusing our development and commercialization efforts on differentiated products that we can market through our sales channel.   These innovative products are designed to drive penetration within specific growth segments of the overall spine market, including the complex spine, deformity, and lateral markets.  In Q1 of 2017 we delivered limited market releases of the Arsenal™ Deformity Adolescent Scoliosis (AIS) System, the Battalion Lateral Spacer System, and the Squadron Lateral Retractor. We also plan to expand our distribution of these offerings as well as broaden our biologics portfolio through structural allograft, tissue and synthetic bone graft products to support surgeons during the surgical procedure with the goal of achieving high fusion rates.  

Spine Anatomy

The spine is the core of the human skeleton and provides important structural support and alignment while remaining flexible to allow movement. The spine is a column of 33 bones that protects the spinal cord and provides the main support for your body. Each bony segment of the spine is referred to as a vertebra (two or more are called vertebrae). The spine has five regions containing groups of similar bones, listed from top to bottom: seven cervical vertebrae in the neck, twelve thoracic vertebrae in the mid-back (each attached to a rib), five lumbar vertebrae in the lower back, five sacral vertebrae fused together to form one bone in the hip region, and four coccygeal bones fused together that form the tailbone. At the front of each vertebra is a block of bone called the vertebral body. Vertebrae are stacked on top of each other and enable people to sit and stand upright. Vertebrae in the cervical, thoracic and lumbar regions are separated from each other and cushioned by a rubbery soft tissue called the intervertebral disc. Strong muscles and bones, flexible tendons and ligaments and sensitive nerves contribute to a healthy spine.  Pain can be caused when any of these structures are affected by strain, injury or disease.

The Alphatec Solution

Our principal product offering includes a wide variety of spinal solutions comprised of components such as access systems, interbody implants, fixation plates, thoracolumbar and cervico/thoracic screws and rods, best-in-class instruments, and various biologics offerings all designed to enhance and promote spinal fusion. Our business is focused on treating conditions from degenerative to complex deformity and trauma through a variety of MIS and traditional procedure.

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The chart below illustrates the principal products in our broad portfolio of spine systems currently available for sale by market segment. Certain systems and products are described in greater detail below the chart.

 

*     Source: Biomed GPS (SmartTraks), iData, Spine Market, Management estimates

**   New product, currently in limited release

*** New product, limited release expected mid-2017

 

MIS Products

Battalion Lateral Spacer System and Squadron Lateral Retractor

The Battalion Lateral Spacer System with the Alphatec Squadron Lateral Retractor provides surgeons with a next-generation lateral system with innovative, unique design characteristics including, total blade control technology that allows the surgeon to maintain approach aperture throughout the procedure, in-situ blade height adjustment and blade replacement, combined with the Battalion Lateral Spacer is available in 0°and 15° lordosis with a variety of width and height options for lumbar and thoracic approaches.  Our Battalion lateral spacer system and Squadron lateral retractor received clearance of a FDA 510-(k) premarket notification from the U.S. Food and Drug Administration, or FDA, in 2016 and we began a limited market release launch in February 2017.

XYcor Expandable Spinal Spacer System

The XYcor Expandable Spinal Spacer System provides surgeons with a minimally invasive inspired solution for PLIF and TLIF procedures by utilizing a smaller, more compact ALIF sized implant that can accommodate a variety of patient pathologies. The system provides nearly five times the amount of bone graft potential compared to standard PLIF and TLIF cages.  Our XYcor system received FDA 510-(k) clearance in 2016 and we are preparing for limited market release launch in mid 2017.

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Illico Minimally Invasive Surgery System

The Illico Minimally Invasive Surgery System is a cannulated pedicle screw system that is designed to be inserted via a minimally invasive surgical procedure. Access to the spine is gained through a small incision. The surgeon is then able to see the surgical site by using a small canal through which implants are inserted into the patient with a minimum amount of disruption to the surrounding tissue. We believe that the Illico Minimally Invasive Surgery System limits trauma to the tissue surrounding the location of the surgery, which is designed to enable patients to recover faster.

BridgePoint Spinous Process Fixation System

The BridgePoint system is a spinous process fixation system that was developed to address the disadvantages of traditional stabilization devices. The system allows surgeons to fixate the spine using a less invasive approach by attaching a plate to the spinous process of the vertebral body during spinal fusion surgery.

Thoracolumbar Fixation Products

Arsenal Degenerative System

Arsenal Degenerative Spinal Fixation System is a comprehensive system for both simple and complex degenerative spinal fusion procedures. The Arsenal Degenerative Spinal Fixation System was designed to provide operational efficiency, biomechanical strength, and surgical simplicity while providing a complete solution to combat most complex degenerative pathologies. We believe the combination of low-profile implants, intuitive instrumentation and proven strength of this system are significant advantages. The Arsenal Degenerative System was designed to be the platform for future development in other spinal fusion segments of the market including the deformity, MIS and cervico-thoracic segments of the market.

Arsenal Deformity System

The Arsenal Deformity System expands the Arsenal platform to address complex deformity including adult and adolescent diopathic scoliosis, or AIS, spinal deformity pathologies.  The system was thoughtfully designed to provide surgeons with a complete solution to address complex deformity procedures.  The system provides surgeons with unique uniplanar screws, which enable easier screw positioning and rod placement through a tulip that has 360 degrees of rotation while restricting motion in the medial/lateral plane for derotation correction.  Additionally, the system includes a wide variety of low-profile implants providing a better anatomical fit and increased ability to address patient pathologies, ergonomically designed instrumentation to improve surgical efficiency and comfort during complex surgeries and proven biomechanical strength necessary to achieve a solid fusion.

Arsenal CBx Cortical Bone Fixation System

Arsenal CBx is the first extension to the Arsenal platform.  An alternative to traditional pedicle screw placement, Arsenal CBx Cortical Bone Fixation System utilizes a midline approach and cortical bone trajectory to achieve maximum fixation through a less-invasive procedure. This system leverages the strengths of the Arsenal product platform with the benefits of a minimally disruptive procedure to enhance patient outcomes.

Due to the midline approach and inward-outward screw trajectory, soft tissue and muscle exposure requirements are greatly reduced compared to the approach for traditional screw trajectory.  Arsenal CBx is a compatible fixation option for both posterior lumbar interbody fusion or transforaminal lumbar interbody fusion, or PLIF and TLIF, respectively. Additionally, it can be a unique muscle sparing approach to revision surgery.

Zodiac Degenerative Spinal Fixation System

Our Zodiac Degenerative Spinal Fixation System is a comprehensive spinal system that can be used to address both degenerative spinal conditions, as well as deformity correction.  The system offers polyaxial pedicle screws, accompanying implants and advanced instruments for the stabilization of the thoracolumbar spine, as well as deformity specific instrumentation and implants that are designed to enable the surgeon to address patient-specific spinal deformity correction procedures.  

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Cervical and Cervico-Thoracic Products

Trestle Luxe Anterior Cervical Plate System

Our Trestle Luxe Anterior Cervical Plate System has a large window that enables the surgeon to have improved graft site and end plate visualization, which is designed to allow for better placement of the plate. The Trestle Luxe Anterior Cervical Plate System also has a low-profile design, which we believe is among the lowest in the spine market. Low-profile cervical plates are intended to reduce the irritation of the tissue adjacent to the plate following surgery. Other key features of the Trestle Luxe Anterior Cervical Plate include a self-retaining screw-locking mechanism that is designed to ensure quick and easy locking of the plate and a flush profile after the screws are inserted.

Solanas Posterior Cervico/Thoracic Fixation System and Avalon Occipital Plate

Our Solanas Posterior Cervico/Thoracic Fixation System consists of rods, polyaxial screws, hooks, and connectors that provide a solution for posterior cervico/thoracic fusion procedures. We also designed the Solanas Posterior Cervico/Thoracic System to be used in combination with our existing Zodiac Degenerative Spinal Fixation System and our Avalon Occipital Plate, thereby providing surgeons with a solution for occipito-cervico-thoracic fixation. The Avalon Occipital Plate has a unique buttress design for optimal bone graft placement and superior fusion, including three points of plate rotation and translation, which is designed to ease the placement of the plate.

Interbody Systems

Battalion Universal Spacer System

The Battalion Universal Spacer System offers comfort, control and innovative design for surgeons performing PLIF/TLIF procedures. The Battalion implants introduce a new alternative to interbody fusion by combining the elasticity and radiolucency of polyetheretherketone, or PEEK, with a titanium coating for potential osseointegration.

The implants, which come in both a straight and curved footprint, feature a bulleted nose for easy insertion. The Battalion System also features an intuitive and innovative 180-degree locking inserter that assists with protection of neural elements during insertion of the implant. To further market potential, the Battalion System features state-of-the-art instrumentation for disc prep, access and implantation.

Novel PEEK and Titanium Spinal Spacers

Our family of Novel spinal spacers addresses the surgical need to accommodate varying patient anatomies, surgical approaches and composite material options. We offer multiple unique implant designs, each of which is available in numerous shapes and heights. Certain of our Novel spinal spacers are made of titanium and others are made of PEEK.

Alphatec Solus Locking ALIF Spinal Spacer

Our Alphatec Solus locking ALIF spinal spacer, or Alphatec Solus, is a zero-profile PEEK and titanium device offering four points of fixation for improved stability. Alphatec Solus features a one-step insertion and deployment feature and is used in ALIF procedures. We believe that Alphatec Solus’ locking mechanism is a substantial improvement over similar products currently on the market.

Biologics

AlphaGraft Structural Allograft Spacers

We offer a broad portfolio of allograft spacers available in a wide range of shapes and sizes, each with corresponding instrumentation, which are intended for use in the cervical, thoracic, and lumbar regions of the spine. In addition, many of our allograft spacers are packaged in our vacuum-infusion packaging system, or VIP System. The VIP System is a packaging and fluid delivery system that allows for fast and efficient infusion of the surgeon’s choice of hydration fluid. The VIP System provides rapid and uniform hydration, which may reduce the brittleness of the graft and shorten the length of the surgical procedure.

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AlphaGraft ProFuse Demineralized Bone Scaffold

Our AlphaGraft ProFuse Demineralized Bone Scaffold consists of a sponge-like demineralized bone matrix that has been pre-cut into sizes to fit within a spinal spacer. The AlphaGraft ProFuse Demineralized Bone Scaffold provides a natural scaffold derived entirely from bone that can be placed into a void within a spinal spacer or on top of a spinal spacer. The sponge-like qualities of the scaffold allow a surgeon to compress the scaffold and place it into a small space. Following placement, the scaffold expands for maximum contact between the spinal spacer and the endplate of the vertebral body and is designed to promote fusion. The AlphaGraft ProFuse Demineralized Bone Scaffold is pre-packaged in our proprietary VIP System.

Amnioshield Amniotic Tissue Barrier

Our Amnioshield Amniotic Tissue Barrier is an allograft for spinal surgical barrier applications. The composite amniotic membrane reduces inflammation and enhances healing at the surgical site, reduces scar tissue formation and provides an excellent dissection plane.

Alphagraft Demineralized Bone Matrix

Our Alphagraft Demineralized Bone Matrix consists of demineralized human tissue that is mixed with a bioabsorbable carrier and intended for use in surgery for bone grafting.

Neocore Osteoconductive Matrix

Our Neocore Osteoconductive Matrix is designed to provide an effective core environment for bone growth through a synthetic scaffold.  When hydrated with patient bone marrow aspirate, or BMA, Neocore becomes a complete bone graft, which possesses all the necessary components of bone growth.  Engineered to perform like natural bone, Neocore's composition and porosity provide the benefits of rapid revascularization throughout graft and supports replacement of three-dimensional matrix with healthy new bone growth. Offering excellent handling characteristics, these pre-formed strips are flexible to conform to adjacent structures, compressible, and moldable.

Research and Development

Our research and development department seeks to continually improve our core product offering and introduce new products to increase our penetration in the U.S. spine market. We are focused on developing technology platforms that span the largest market segments addressing degenerative and deformity spine pathologies. We have transformed our development process by focusing our resources on two major development programs per year and leveraging integrated teams focused on the key platforms to reduce the time frame from product concept to market commercialization. We also collaborate with our surgeon partners to design products to enhance the surgeon experience, simplify surgical techniques, and reduce overall costs, while improving patient outcomes. Our product development efforts are fully integrated in one facility allowing us to bring products from concept to market rapidly responding to surgeon and patient needs. Our resources include a technology advancement cell for rapid prototyping, a cadaveric lab, and mechanical testing laboratory.

Sales and Marketing

We market and sell our products through a sales force consisting of exclusive and non-exclusive independent distributors and employee direct sales representatives.  We employ a team of regional sales managers who are responsible for overseeing the overall sales channel process in their territories. Although surgeons in the U.S. typically make the ultimate decision to use our products, we generally bill the hospital for the products that are used and pay commissions to the sales representative or the sales agent based on payment received from the hospital. We compensate our direct sales employees and regional sales managers through salaries and incentive bonuses based on performance measures.  

In late 2016 we evaluated our sales distribution channel and are currently in the process of making significant changes to drive a more dedicated and loyal sales channel.  Moving forward we intend to eliminate our traditional stocking distributors, move our existing distributor relationships to more exclusive partnerships and attract new, high-quality distributors to enable future growth.  We believe these changes will provide us with significant opportunity for future growth as we secure more exclusive distribution partners that can further penetrate existing and new geographic markets.

We evaluate and select our distribution partners and sales employees based on their expertise in selling spinal devices, reputation within the surgeon community, geographical coverage and established sales network.

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We also employ a national accounts team that is responsible for securing access at hospitals and GPOs, across the U.S. We have had strong success with securing access to hospitals and GPOs.  We believe this access is a key differentiator for us and much of our current business is achieved through these accounts.  We will continue to focus our efforts and investment on developing and maintaining relationships with key GPOs and hospital networks to secure favorable contracts and develop strategies to convert or grow business within existing accounts.      

We market our products at various industry conferences, organized surgical training courses, and in industry trade journals and periodicals.

Surgeon Training and Education

We focus our surgeon training efforts on delivering critical technical skills needed on the entire spinal fusion procedure through a peer-to-peer approach to qualified surgeon customers.  Well-timed surgeon education programs drive customer conversion and loyalty through leadership and excellence by focusing on delivering value through improved surgeon outcomes.  We devote significant resources to training and education and are committed to a culture of scientific excellence and ethics.

We believe that one of the most effective ways to introduce and build market demand for our products is by training and educating spine surgeons, independent distributors, and direct sales representatives in the benefits and use of our products.  Sales training programs will be a platform for learning and organizational development, ensuring the sales force is clinically competitive and considered an essential resource to all stakeholders.  We focus on cross functional collaboration and alignment to deliver timely and relevant programs to meet surgeon and representative needs and positively impact the business.  

Our training and education programs are designed to support new product introductions to the market as well as ongoing portfolio advancement.  Our resources are nimble and responsive and include field based engagements to supplement our core curriculum.  We believe this is an effective way to increase overall surgeon adoption of our new products.  

We believe that surgeons, independent distributors, and direct sales representatives will become exposed to the merits and distinguishing features of our products through our training and education programs, and that such exposure will increase the use and promotion of our products. With a focus on the entire procedure, we expect to build awareness of the breadth of our product offering.  We are conscientious in the pursuit of delivering value to all stakeholders.  Our goal is to provide surgeon education programs coupled with a growing and comprehensive sales training platform that create a sustainable competitive advantage for our organization.

Manufacture and Supply

We rely on third-party suppliers for the manufacture of all our implants and instruments. Outsourcing implant manufacturing reduces our need for capital investment and reduces operational expense. Additionally, outsourcing provides expertise and capacity necessary to scale up or down based on demand for our products.  We select our suppliers to ensure that all of our products are safe, effective, adhere to all applicable regulations, are of the highest quality, and meet our supply needs. We employ a rigorous supplier assessment, qualification, and selection process targeted to suppliers that meet the requirements of the U.S. Food and Drug Administration, or FDA, and International Organization for Standardization, or ISO, and quality standards supported by internal policies and procedures. Our quality assurance process monitors and maintains supplier performance through qualification and periodic supplier reviews and audits.

The raw materials used in the manufacture of our non-biologic products are principally titanium, titanium alloys, stainless steel, cobalt chrome, ceramic, allograft, and PEEK. With the exception of PEEK, none of our raw material requirements is limited to any significant extent by critical supply. We are subject to the risk that Invibio, one of a limited number of PEEK suppliers, will fail to supply PEEK in adequate amounts and in a timely manner. We believe our supplier relationships and quality processes will support our potential capacity needs for the foreseeable future.

With respect to biologics products, we are FDA-registered and licensed in the states of California, New York, and Florida, the only states that currently require licenses. Our facility and the facilities of the third-party suppliers we use are subject to periodic unannounced inspections by regulatory authorities and may undergo compliance inspections conducted by the FDA and corresponding state and foreign agencies. Because our biologics products are processed from human tissue, maintaining a steady supply can sometimes be challenging. We have not experienced significant difficulty in locating and obtaining the materials necessary to fulfill our production requirements, and we have not experienced a meaningful disruption to sales orders.

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Divestiture of International Business

On September 1, 2016, we closed a sale of our international distribution operations and agreements to Globus Medical Ireland, Ltd., or the Buyer, a subsidiary of Globus Medical, Inc., or Globus, or the Globus Transaction.  Pursuant to the Globus Transaction, Globus acquired: (i) all of the stock of our wholly-owned subsidiaries in Japan, Brazil, Australia, China and Singapore; (ii) substantially all of the assets of our other sales operations in the United Kingdom and Italy; and (iii) all of the other assets that are related to the business of the design, development, marketing, promotion and sale of products for the surgical treatment of spine disorders that we market and sell outside of the United States.  The Globus Transaction was completed pursuant to a purchase and sale agreement, dated as of July 25, 2016, as amended, or the Purchase and Sale Agreement.  Pursuant to the Purchase and Sale Agreement we have agreed to not market and sell spinal implant products outside of the United States for a period beginning after the closing of the Globus Transaction and ending two years following the termination of the Supply Agreement defined below. 

Under the terms of the Purchase and Sale Agreement, at the closing of the Globus Transaction the Buyer paid us $80 million in cash, subject to a working capital adjustment.  In addition, at the closing of the Globus Transaction we entered into a five-year term credit facility agreement, or the Globus Facility Agreement, with Globus, pursuant to which Globus agreed to loan us up to $30 million. 

In addition, at the closing of the Globus Transaction, we and Globus entered into a product manufacture and supply agreement, or the Supply Agreement, pursuant to which, at agreed-upon prices, we agreed to supply to Globus certain of our implants and instruments that at the time were being offered for sale by us outside of the United States.  Pursuant to the Supply Agreement, we will be responsible for ensuring that all of the products delivered to Globus meet all agreed-upon specifications for such products.  The Supply Agreement has an initial term of three years, and Globus has the right to renew the Supply Agreement for two additional 12-month periods; subject to Globus meeting certain purchase requirements.

Competition

Although we believe that our current broad product portfolio and development pipeline is differentiated and has numerous competitive advantages, the spinal implant industry is highly competitive, subject to rapid technological change, and significantly affected by new product introductions. We believe that the principal competitive factors in our market include:

 

improved outcomes for spine pathology procedures;

 

ease of use, quality and reliability of product portfolio;

 

effective and efficient sales, marketing and distribution;

 

quality service and an educated and knowledgeable sales network;

 

technical leadership and superiority;

 

surgeon services, such as training and education;

 

responsiveness to the needs of surgeons;

 

acceptance by spine surgeons;

 

product price and qualification for reimbursement; and

 

speed to market.

Both our currently marketed products and any future products we commercialize are subject to intense competition. We believe that our most significant competitors are Medtronic Sofamor Danek, Johnson & Johnson (DePuy/Synthes), Stryker, NuVasive, Zimmer, Biomet, Globus, K2M Medical, SeaSpine and others, many of which have substantially greater financial resources than we do. In addition, these companies may have more established distribution networks, entrenched relationships with physicians and greater experience in developing, launching, marketing, distributing and selling spinal implant products.

Some of our competitors also provide non-operative therapies for spine disorder conditions. While these non-operative treatments are considered to be an alternative to surgery, surgery is typically performed in the event that non-operative treatments are unsuccessful. We believe that, to date, these non-operative treatments have not caused a material reduction in the demand for surgical treatment of spinal disorders.

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Intellectual Property

We rely on a combination of patent, trademark, copyright, trade secret and other intellectual property laws, nondisclosure agreements, proprietary information ownership agreements and other measures to protect our intellectual property rights. We believe that in order to have a competitive advantage, we must develop, maintain and enforce the proprietary aspects of our technologies. We require our employees, consultants, co-developers, distributors and advisors to execute agreements governing the ownership of proprietary information and use and disclosure of confidential information in connection with their relationship with us. In general, these agreements require these individuals and entities to agree to disclose and assign to us all inventions that were conceived on our behalf or which relate to our property or business and to keep our confidential information confidential and only use such confidential information in connection with our business.

Patents

As of March 14, 2017, we and our affiliates owned, or exclusively owned 111 issued U.S. patents, 72 pending U.S. patent applications and 231 issued or pending foreign patents. We own multiple patents relating to unique aspects and improvements for several of our products. We do not believe that the expiration of any single patent is likely to significantly affect our intellectual property position.

Trademarks

As of March 14, 2017, we and our affiliates owned 72 registered U.S. trademarks and 148 registered trademarks outside of the U.S..

Government Regulation

Our products are subject to extensive regulation by the FDA and other U.S. federal and state regulatory bodies and comparable authorities in other countries. Our products are subject to regulation under the Federal Food, Drug, and Cosmetic Act, or FDCA, and in the case of our tissue products, also under the Public Health Service Act, or PHSA.  To ensure that our products are safe and effective for their intended use, the FDA regulates, among other things, the following activities that we or our partners perform and will continue to perform:

 

product design and development;

 

product testing;

 

non-clinical and clinical research;

 

product manufacturing;

 

product labeling;

 

product storage;

 

premarket clearance or approval;

 

advertising and promotion;

 

product marketing, sales and distribution;

 

import and export; and

 

post-market surveillance, including reporting deaths or serious injuries related to products and certain product malfunctions.

Government Regulation – Medical Devices

FDA’s Premarket Clearance and Approval Requirements

Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either FDA clearance of a premarket notification requesting permission for commercial distribution under Section 510(k) of the Federal Food, Drug and Cosmetic Act, or FDCA, also referred to as a 510(k) clearance, or approval of a premarket approval application, or PMA. The information that must be submitted to the FDA in order to obtain clearance or approval to market a new medical device varies depending on how the medical device is classified by the FDA. Under the FDCA medical devices are classified into one of three classes —Class I, Class II or Class III—depending on the degree of risk associated with the use of the device and the extent of manufacturer and regulatory controls deemed to be necessary by the FDA to reasonably ensure their safety and effectiveness.

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Class I devices are those with the lowest risk to the patient for which safety and effectiveness can be reasonably assured by adherence to a set of regulations, referred to as General Controls, which require compliance with the applicable portions of the FDA's Quality System Regulation, or QSR, facility registration and product listing, reporting of adverse events and malfunctions, and appropriate, truthful and non-misleading labeling and promotional materials. Some Class I devices also require 510(k) clearance by the FDA, though most Class I devices are exempt from the premarket notification requirements.  Class II devices are those that are subject to the General Controls, as well as Special Controls, which can include performance standards, product-specific guidance documents and postmarket surveillance. Manufacturers of most Class II devices are required to submit to the FDA a premarket notification under Section 510(k) of the FDCA.  Class III devices include devices deemed by the FDA to pose the greatest risk such as life-supporting or life-sustaining devices, or implantable devices, in addition to those deemed not substantially equivalent following the 510(k) process. The safety and effectiveness of Class III devices cannot be reasonably assured solely by compliance with the General Controls and Special Controls described above. Therefore, these devices must be the subject of an approved PMA.  Both 510(k)s and PMAs are subject to the payment of user fees at the time of submission for FDA review.

If the FDA determines that the device is not "substantially equivalent" to a predicate device following submission and review of a 510(k) premarket notification, or if the manufacturer is unable to identify an appropriate predicate device and the new device or new use of the device presents a moderate or low risk, the device sponsor may either pursue a PMA approval or seek reclassification of the device through the de novo process. Our current products on the market in the U.S. are Class II devices marketed under FDA 510(k) premarket clearance.

510(k) Clearance Pathway

To obtain 510(k) clearance, we must submit a premarket notification demonstrating that the proposed device is substantially equivalent to a device legally marketed in the United States. A predicate device is a legally marketed device that is not subject to premarket approval, i.e., a device that was legally marketed prior to May 28, 1976 (pre-amendments device) and for which a PMA is not required, a device that has been reclassified from Class III to Class II or I, or a device that was found substantially equivalent through the 510(k) process.  To be "substantially equivalent," the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data is sometimes required to support substantial equivalence.

The FDA’s goal is to review and act on each 510(k) within 90 days of submission, but the process usually takes from nine to 12 months, and it may take longer if the FDA requests additional information. Most 510(k)s do not require supporting data from clinical trials, but the FDA may request such data.  If the FDA agrees that the device is substantially equivalent, it will grant clearance to commercially market the device.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, will require a new 510(k) clearance or, depending on the modification, require premarket approval. The FDA requires each manufacturer to determine whether the proposed change requires the submission of a 510(k) or PMA, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA is obtained. If the FDA requires us to seek a new 510(k) clearance or PMA for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant fines or penalties. We have made and plan to continue to make enhancements to our products for which we have not submitted 510(k)s or PMAs, and we will consider on a case-by-case basis whether a new 510(k) or PMA is necessary.

The FDA began to consider proposals to reform its 510(k) marketing clearance process in 2011, and such proposals could include increased requirements for clinical data and a longer review period. Specifically, in response to industry and healthcare provider concerns regarding the predictability, consistency and rigor of the 510(k) regulatory pathway, the FDA initiated an evaluation of the 510(k) program, and as part of the Food and Drug Administration Safety and Innovation Act, or FDASIA, Congress reauthorized the Medical Device User Fee Amendments with various FDA performance goal commitments and enacted several “Medical Device Regulatory Improvements” and miscellaneous reforms, which are further intended to clarify and improve medical device regulation both pre- and post-clearance and approval.  Further, in December 2016, the 21st Century Cures Act, or Cures Act, was signed into law.  The Cures Act, among other things, is intended to modernize the regulation of devices and spur innovation, but its ultimate implementation is unclear.

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Premarket Approval Pathway

Class III devices require PMA approval before they can be marketed, although some pre-amendment Class III devices for which the FDA has not yet required a PMA are cleared through the 510(k) process.  The PMA process is generally more complex, costly and time consuming than the 510(k) process. A PMA must be supported by extensive data including, but not limited to, extensive technical information regarding device design and development, preclinical and clinical trials, manufacturing and labeling information to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use. The PMA application must provide valid scientific evidence that demonstrates to the FDA's satisfaction reasonable assurance of the safety and effectiveness of the device for its intended use.  Following receipt of a PMA, the FDA determines whether the application is sufficiently complete to permit a substantive review.  If the FDA accepts the application for review, it has 180 days under the FDCA to complete its review of the PMA, although in practice, the FDA’s review often takes significantly longer, and can take up to several years.  During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant's response to deficiencies communicated by the FDA. Also during the review period, an advisory panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. The FDA may or may not accept the panel’s recommendation.  In addition, the FDA will conduct a preapproval inspection of the manufacturing facility to ensure compliance with quality system regulation, or QSR. The PMA process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought by other companies have never been approved by the FDA for marketing

Clinical Trials

Clinical trials are almost always required to support a PMA and are sometimes required for a 510(k). All clinical investigations of investigational devices to determine safety and effectiveness must be conducted in accordance with the FDA’s investigational device exemption, or IDE, regulations which govern investigational device labeling, prohibit promotion of the investigational device, and specify an array of recordkeeping, reporting and monitoring responsibilities of study sponsors and study investigators.   If the device is determined to present a “significant risk” to human health, the manufacturer may not begin a clinical trial until it submits an IDE application to the FDA and obtains approval of the IDE from the FDA. The IDE must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. In addition, the study must be approved by, and conducted under the oversight of, an Institutional Review Board, or IRB, for each clinical site. The IRB is responsible for the initial and continuing review of the IDE, and may pose additional requirements for the conduct of the study. If an IDE application is approved by the FDA and one or more IRBs, human clinical trials may begin at a specific number of investigational sites with a specific number of patients, as approved by the FDA. If the device presents a non-significant risk to the patient, a sponsor may begin the clinical trial after obtaining approval for the trial by one or more IRBs without separate approval from the FDA, but must still follow abbreviated IDE requirements, such as monitoring the investigation, ensuring that the investigators obtain informed consent, and labeling and record-keeping requirements. A clinical trial may be suspended by FDA, the sponsor or an IRB at any time for various reasons, including a belief that the risks to the study participants outweigh the benefits of participation in the trial. Even if a clinical trial is completed, the results may not demonstrate the safety and efficacy of a device to the satisfaction of the FDA, or may be equivocal or otherwise not be sufficient to obtain approval of a device.

Pervasive and Continuing FDA Regulation

After a device is placed on the market, numerous FDA and other regulatory requirements continue to apply. These include:

 

registration and listing requirements, which require manufacturers to register all manufacturing facilities and list all medical devices placed into commercial distribution;

 

the QSR, which requires manufacturers, including third-party contract manufacturers, to follow stringent design, testing, control, supplier/contractor selection, documentation, record maintenance and other quality assurance controls, during all aspects of the manufacturing process and to maintain and investigate complaints;

 

labeling regulations and unique device identification requirements;

 

advertising and promotion requirements;

 

restrictions on sale, distribution or use of a device;

 

FDA prohibitions against the promotion of products for uncleared or unapproved “off-label” uses;medical device reporting obligations, which require that manufacturers submit reports to the FDA of device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to reoccur;;

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medical device correction and removal reporting regulations, which require that manufacturers report to the FDA field corrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FDCA that may present a risk to health;

 

device tracking requirements; and

 

other post-market surveillance requirements, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device.

Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following:

 

warning letters and untitled letters;

 

fines, injunctions, consent decrees, and civil penalties;

 

recalls, withdrawals, administrative detention, or seizure of products;

 

operating restrictions, partial suspension or total shutdown of production;

 

withdrawals of 510(k) clearances or PMA approvals that have already been granted;

 

refusal to grant 510(k) clearance or PMA approvals of new products; and/or

 

criminal prosecution.

Our facilities, records and manufacturing processes are subject to periodic announced and unannounced inspections by the FDA to evaluate compliance with applicable regulatory requirements.

Regulation of Human Cells, Tissues, and Cellular and Tissue-based Products

Certain of our products are regulated as human cells, tissues, and cellular and tissue-based products, or HCT/Ps.  Section 361 of the PHSA authorizes the FDA to issue regulations to prevent the introduction, transmission or spread of communicable disease. HCT/Ps regulated as “361” HCT/Ps are subject to requirements relating to registering facilities and listing products with the FDA, screening and testing for tissue donor eligibility, or Good Tissue Practice, when processing, storing, labeling, and distributing HCT/Ps, including required labeling information, stringent record keeping, and adverse event reporting, among other applicable requirements and laws. If the HCT/P is minimally manipulated, is intended for homologous use only and meets other requirements, the HCT/P will not require 510(k) clearance, PMA approval, a Biologics License Applications, or other premarket authorization from the FDA before marketing.

Environmental Matters

Our facilities and operations are subject to extensive federal, state, and local environmental and occupational health and safety laws and regulations. These laws and regulations govern, among other things, air emissions; wastewater discharges; the generation, storage, handling, use and transportation of hazardous materials; the handling and disposal of hazardous wastes; the cleanup of contamination; and the health and safety of our employees. Under such laws and regulations, we are required to obtain permits from governmental authorities for some of our operations. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators. We could also be held responsible for costs and damages arising from any contamination at our past or present facilities or at third-party waste disposal sites. We cannot completely eliminate the risk of contamination or injury resulting from hazardous materials, and we may incur material liability as a result of any contamination or injury.

Compliance with Certain Applicable Statutes

We are subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws, false claims laws, criminal health care fraud laws, physician payment transparency laws, data privacy and security laws and foreign corrupt practice laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, fines, imprisonment and, within the United States, exclusion from participation in government healthcare programs, including Medicare, Medicaid and Veterans Administration health programs. These laws are administered by, among others, the U.S. Department of Justice, the Office of Inspector General of the Department of Health and Human Services and state attorneys general. Many of these agencies have increased their enforcement activities with respect to medical device manufacturers in recent years.

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The federal Anti-Kickback Statute, prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, for which payment may be made in whole or part under federal healthcare programs, such as the Medicare and Medicaid programs. The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. For example, the definition of “remuneration” has been broadly interpreted to include anything of value, including, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash, waivers of payments, ownership interests and providing anything at less than its fair market value. In addition, the Patient Protection and Affordable Health Care Act, which, as amended by the Health Care and Education Reconciliation Act, and collectively referred to as ACA. ACA, among other things, amends the intent requirement of the federal Anti-Kickback Statute. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, ACA provides that the government may assert that a claim including items or services resulting from a violation of the Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal False Claims Act.

In implementing the Anti-Kickback Statute, the Department of Health and Human Services Office of Inspector General, or OIG, has issued a series of regulations, known as the safe harbors, which began in July 1991. These safe harbors set forth provisions that, in circumstances where all the applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy all requirements of an applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG. Penalties for violations of the Anti-Kickback Statute include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. Many states have anti-kickback laws that are similar to the federal law, some of which apply to the referral of patients for healthcare items or services reimbursed by any source, and may also result in penalties, fines, sanctions for violations, and exclusions from state or commercial programs.

We have entered into various agreements with certain surgeons that perform services for us, including some who make clinical decisions to use our products. Some of our referring surgeons own our stock, which they received from us as consideration for services performed.  From time to time, we review these arrangements to determine whether they are in compliance with applicable laws and regulations.  In addition, physician-owned distribution companies, or PODs, have increasingly become involved in the sale and distribution of medical devices, including products for the surgical treatment of spine disorders. In many cases, these distribution companies enter into arrangements with hospitals that bill Medicare or Medicaid for the furnishing of medical services, and the physician-owners are among the physicians who refer patients to the hospitals for surgery. On March 26, 2013 the OIG issued a Special Fraud Alert entitled "Physician-Owned Entities", or the Fraud Alert, in which the OIG concluded, among other things, that PODs are "inherently suspect under the anti-kickback statute" and that PODs present "substantial fraud and abuse risk and pose dangers of patient safety." Since 2013, the OIG has further increased its scrutiny of PODs and the Department of Justice has brought several high-profile cases against physician owners.

The federal False Claims Act prohibits persons from knowingly filing or causing to be filed a false or fraudulent claim to, or the knowing use of false statements to obtain payment from, the federal government. Private suits filed under the False Claims Act, known as qui tam actions, can be brought by individuals on behalf of the government. These individuals, sometimes known as “relators” or, more commonly, as “whistleblowers,” may share in any amounts paid by the entity to the government in fines or settlement. The number of filings of qui tam actions has increased significantly in recent years, causing more healthcare companies to have to defend a False Claim Act action. If an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $10,000 to $22,000 for each separate false claim and may be subject to exclusion from Medicare, Medicaid and other federal healthcare programs. Various states have also enacted similar laws modeled after the federal False Claims Act which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor.

The Health Insurance Portability and Accountability Act, or HIPAA, created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. The ACA changed the intent requirement of the healthcare fraud statute to such that a person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. A violation of this statute is a felony and may result in fines, imprisonment or possible exclusion from Medicare, Medicaid and other federal healthcare programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in similar sanctions.

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ACA also includes various provisions designed to strengthen significantly fraud and abuse enforcement in addition to those changes discussed above. Among these additional provisions include increased funding for enforcement efforts and new “sunshine” provisions to require us to report and disclose to the Centers for Medicare and Medicaid Services, or CMS, any payment or “transfer of value” made or distributed to physicians or teaching hospitals. These sunshine provisions also require certain group purchasing organizations, including physician-owned distributors, to disclose physician ownership information to CMS. We and other device manufacturers are required to collect and annually report specific data on payments and other transfers of value to physicians and teaching hospitals. There are various state laws and initiatives that require device manufacturers to disclose to the appropriate regulatory agency certain payments or other transfers of value made to physicians, and in certain cases prohibit some forms of these payments, with the risk of fines for any violation of such requirements.

HIPAA also includes privacy and security provisions designed to regulate the use and disclosure of “protected health information”, or PHI, which is health information that identifies a patient and that is held by a health care provider, a health plan or health care clearinghouse. We are not directly regulated by HIPAA, but our ability to access PHI for purposes such as marketing, product development, clinical research or other uses is controlled by HIPAA and restrictions placed on health care providers and other covered entities. HIPAA was amended in 2009 by the Health Information Technology for Economic and Clinical Health Act, or HITECH, which strengthened the rule, increased penalties for violations and added a requirement for the disclosure of breaches to affected individuals, the government and in some cases the media. We must carefully structure any transaction involving PHI to avoid violation of HIPAA and HITECH requirements.

Almost all states have adopted data security laws protecting personal information including social security numbers, state issued identification numbers, credit card or financial account information coupled with individuals’ names or initials. We must comply with all applicable state data security laws, even though they vary extensively, and must ensure that any breaches or accidental disclosures of personal information are promptly reported to affected individuals and responsible government entities. We must also ensure that we maintain compliant, written information security programs or run the risk of civil or even criminal sanctions for non-compliance as well as reputational harm for publicly reported breaches or violations.

If any of our operations are found to have violated or be in violation of any of the laws described above and other applicable state and federal fraud and abuse laws, we may be subject to penalties, among them being civil and criminal penalties, damages, fines, exclusion from government healthcare programs, and the curtailment or restructuring of our operations.

Third-Party Reimbursement

In the U.S., healthcare providers generally rely on third-party payors, principally private insurers and governmental payors such as Medicare and Medicaid, to cover and pay for all or part of the cost of a spine surgery in which our medical devices are used. We expect that sales volumes and prices of our products will depend in large part on the continued availability of reimbursement from such third-party payors. These third-party payors may deny reimbursement if they determine that a device used in a procedure was not medically necessary in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Particularly in the U.S., third-party payors continue to carefully review, and increasingly challenge, the prices charged for procedures and medical products. Medicare coverage and reimbursement policies are developed by CMS, the federal agency responsible for administering the Medicare program, and its contractors. CMS establishes these Medicare policies for medical products and procedures and such policies are periodically reviewed and updated. While private payors vary in their coverage and payment policies, the Medicare program is viewed as a benchmark. Medicare payment rates for the same or similar procedures vary due to geographic location, nature of the facility in which the procedure is performed (i.e., teaching or community hospital) and other factors. We cannot assure you that government or private third-party payors will cover and provide adequate payment for the procedures in which our products are used. ACA and other reform proposals contain significant changes regarding Medicare, Medicaid and other third party payors.

Among these changes was the imposition of a 2.3% excise tax on domestic sales of medical devices that went into effect on January 1, 2013. This tax has resulted in a significant increase in the tax burden on our industry. In December 2015, the U.S. Congress adopted and President Obama signed into law the Consolidated Appropriations Act of 2016.  Among other things, this legislation put in place a two-year moratorium on the device tax through the end of 2017.  Other elements of the ACA include numerous provisions to limit Medicare spending through reductions in various fee schedule payments and by instituting more sweeping payment reforms, such as bundled payments for episodes of care, the establishment of “accountable care organizations” under which hospitals and physicians will be able to share savings that result from cost control efforts, comparative effectiveness research, value-based purchasing, and the establishment of an independent payment advisory board.

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We expect that the new Presidential administration and U.S. Congress will seek to modify, repeal, or otherwise invalidate all, or certain provisions of, the ACA. Since its enactment, there have also been other judicial and Congressional challenges to certain aspects of the ACA. As a result, there have been delays in the implementation of, and action taken to repeal or replace, certain aspects of the ACA. In March 2017, the United States House of Representatives introduced legislation known as the American Health Care Act, or the AHCA, which, if enacted, would amend or repeal significant portions of the ACA. Among other changes, the AHCA, would repeal the medical device tax, eliminate penalties on individuals and employers that fail to maintain or provide minimum essential coverage and create refundable tax credits to assist individuals in buying health insurance. The AHCA would also make significant changes to Medicaid by, among other things, making Medicaid expansion optional for states, repealing the requirement that state Medicaid plans provide the same essential health benefits that are required by plans available on the exchanges, modifying federal funding, including implementing a per capita cap on federal payments to states, and changing certain eligibility requirements. While it is uncertain when or if the provisions in the AHCA will become law, or the extent to which any such changes may impact our business, it is clear that concrete steps are being taken to repeal and replace certain aspects of the ACA.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. These changes include the Budget Control Act of 2011, which resulted in reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013 and will stay in effect through 2025 unless additional Congressional action is taken, as well as, the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several types of providers, including hospitals and imaging centers, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years. An expansion in government’s role in the U.S. healthcare industry may lower reimbursements for procedures using our products, reduce medical procedure volumes, and adversely affect our business and results of operations, possibly materially.

We believe that the overall escalating cost of medical products and services has led to, and will continue to lead to, increased pressures on the healthcare industry to reduce the costs of products and services. We cannot assure you that government or private third-party payors will cover and provide adequate payment for the procedures using our products. In addition, it is possible that future legislation, regulation, or reimbursement policies of third-party payors will adversely affect the demand for procedures using our products or our ability to sell our products on a profitable basis. The unavailability or inadequacy of third-party payor coverage or reimbursement could have a significant adverse effect on our business, operating results and financial condition.

Employees

As of December 31, 2016, we had 162 employees in the U.S., approximately 140 of which were based in our Carlsbad, California headquarters, covering all of the following functional areas: sales, customer service, marketing, clinical education, advanced manufacturing, quality assurance, regulatory affairs, research and development, human resources, finance, legal, information technology and administration. We have never experienced a work stoppage due to labor difficulties and believe that our relations with our employees are good. We currently have no employees working under collective bargaining agreements.  On February 1, 2017, we implemented a workforce reduction, aimed at further aligning our employee count and operating expense with our current revenues.  As of March 21, 2017, we have 142 employees, all located within the U.S., of which 119 are based in our Carlsbad, California headquarters.

Corporate and Available Information

We are a Delaware corporation. We were incorporated in March 2005. Our principal executive office is located at 5818 El Camino Real, Carlsbad, California 92008. Our Internet address is www.alphatecspine.com.  We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, are available to you free of charge through the Investor Relations section of our website as soon as reasonably practicable after such materials have been electronically filed with, or furnished to, the Securities and Exchange Commission, or SEC.

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Item 1A.

Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained or incorporated by reference in this Annual Report on Form 10-K. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any of such risks or the risks described below, either alone or taken together, occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment.

Risks Related to Our Business and Industry

Our business plan relies on certain assumptions pertaining to the market for our products that, if incorrect, may adversely affect our growth and profitability.

We allocate our design, development, marketing, management and financial resources based on our business plan, which includes assumptions about various demographic trends and trends in the treatment of spine disorders and the resulting demand for our products. However, these trends are uncertain. There can be no assurance that our assumptions with respect to an aging population with broad medical coverage and longer life expectancy, which we expect to lead to increased spinal injuries and degeneration, are accurate. In addition, an increasing awareness and use of non-invasive means for the prevention and treatment of back pain and rehabilitation purposes may reduce demand for, or slow the growth of sales of, spine fusion products. A significant shift in technologies or methods used in the treatment of back pain or damaged or diseased bone and tissue could adversely affect demand for some or all of our products. For example, pharmaceutical advances could result in non-surgical treatments gaining more widespread acceptance as a viable alternative to spine fusion. The emergence of new biological or synthetic materials to facilitate regeneration of damaged or diseased bone and to repair damaged tissue could increasingly minimize or delay the need for spine fusion surgery and provide other biological alternatives to spine fusion. New surgical procedures could diminish demand for some of our products. The increased acceptance of emerging technologies that do not require spine fusion, such as artificial discs and nucleus replacement, for the surgical treatment of spine disorders would reduce demand for, or slow the growth of sales of, spine fusion products. If our assumptions regarding these factors prove to be incorrect or if alternative treatments to those offered by our products gain further acceptance, then demand for our products could be significantly less than we anticipate and we may not be able to achieve or sustain growth or profitability.

We are in a highly competitive market segment, face competition from large, well-established medical device companies with significant resources, and may not be able to compete effectively.

The market for spine fusion products and procedures is intensely competitive, subject to rapid technological change and significantly affected by new product introductions and other market activities of industry participants. In 2016, a significant percentage of global spine implant product revenues was generated by Medtronic Sofamor Danek, a subsidiary of Medtronic, Inc.; Depuy Spine, a subsidiary of Johnson & Johnson; and Stryker Spine. Our competitors also include numerous other publicly-traded and privately-held companies such as NuVasive, Zimmer, Biomet, Globus, K2M Medical and SeaSpine.

Several of our competitors enjoy competitive advantages over us, including:

 

more established relationships with spine surgeons;

 

more established distribution networks;

 

broader spine surgery product offerings;

 

stronger intellectual property portfolios;

 

greater financial and other resources for product research and development, sales and marketing, and patent litigation;

 

greater experience in, and resources for, launching, marketing, distributing and selling products;

 

significantly greater name recognition as well as more recognizable trademarks for products similar to the products that we sell;

 

more established relationships with healthcare providers and payors;

 

products supported by more extensive clinical data; and

 

greater experience in obtaining and maintaining FDA and other regulatory clearances or approvals for products and product enhancements.

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In addition, at any time our current competitors or other companies may develop alternative treatments, products or procedures for the treatment of spine disorders that compete directly or indirectly with our products, including ones that prove to be superior to our spine surgery products. For these reasons, we may not be able to compete successfully against our existing or potential competitors. Any such failure could lead us to modify our strategy, lower our prices, increase the commissions we pay on sales of our products and have a significant adverse effect on our business, financial condition and results of operations.

The sale of our international distribution operations and agreements will reduce our revenue, and we may not be successful in executing on our business strategy to solely focus on the U.S. marketplace.

Prior to the sale of our International operations in September 2016, our international revenue represented approximately 35% of our total revenue for the six months ended June 30, 2016 and year ended December 31, 2015. Following the closing of the Globus Transaction, our revenues have been and will continue to be materially reduced as we will no longer be generating the same level of revenue from the operations and assets sold in the transaction. There can be no assurance that the proceeds from the Globus Transaction will be sufficient for us to grow our U.S. business.  In addition, our future growth will depend on our ability to successfully implement our strategy to focus solely on the U.S. marketplace.  If we are unable to successfully execute on this business strategy or otherwise compete effectively within the U.S. marketplace, our business, financial condition, results of operations and growth prospects would be materially and adversely affected.

We may face indemnity and other liability claims pursuant to the Globus Purchase and Sale Agreement.

Under the purchase and sale agreement for the Globus Transaction, we will indemnify Globus against damages arising from, among other things, breaches of our representations, warranties or obligations under the agreement and liabilities not assumed by Globus. The indemnification period generally runs for a period of 18 months from the Closing, with longer survival periods for certain specified representations and warranties. Our indemnification obligations are subject to a deductible in certain cases of $500,000, and our aggregate liability under such indemnification claims is generally limited to $12.0 million, $20.0 million for certain specified representations and warranties, and the full purchase price for breaches of certain specified representations and warranties, breaches of covenants and certain other matters. If Globus makes an indemnification claim, we may incur liability and/or expenses, which could harm our operating results. In addition, such indemnity claims may divert management attention from our continuing business.

A significant percentage of our revenues are derived from the sale of our systems that include polyaxial pedicle screws.

Net sales of our systems that include polyaxial pedicle screws represented approximately 50% of our net sales for 2016 and 2015. A decline in sales of these systems, due to lower market demand, the introduction by a third party of a competitive product, an intellectual property dispute involving these systems, or otherwise, would have a significant adverse impact on our business, financial condition and results of operations. Some of the technology related to our polyaxial pedicle screw systems is licensed to us. Any action that would prevent us from manufacturing, marketing and selling our polyaxial pedicle screw systems would have a significant adverse effect on our business, financial condition and results of operations.

Our sales and marketing efforts are largely dependent upon third parties, many of which are free to market products that compete with our products.

Many of our independent distributors also market and sell the products of our competitors, and those competitors may have the ability to influence the products that our independent distributors choose to market and sell. Our competitors may be able, by offering higher commission payments or otherwise, to convince our independent distributors to terminate their relationships with us, carry fewer of our products or reduce their sales and marketing efforts for our products.

If pricing pressures cause us to decrease prices for our goods and services and we are unable to compensate for such reductions through changes in our product mix or reductions to our expenses, our results of operations will suffer.

We have experienced and may continue to experience decreasing prices for our goods and services we offer due to pricing pressure exerted by our customers in response to increased cost containment efforts from managed care organizations and other third-party payors and increased market power of our customers as the medical device industry consolidates. If we are unable to offset such price reductions through changes in our product mix or reductions in our expenses, our business, financial condition, results of operations and cash flows will be adversely affected.

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To be commercially successful, we must convince the spine surgeon community that our products are an attractive alternative to our competitors’ products. If the spine surgeon community does not use our products, our sales will decline and we will be unable to increase our sales and profits.

In order for us to sell our products, surgeons must be convinced that our products are superior to competing products. Acceptance of our products depends on educating the spine surgeon community as to the distinctive characteristics, perceived benefits, safety and cost-effectiveness of our products compared to our competitors’ products and on training surgeons in the proper application of our products. If we are not successful in convincing the spine surgeon community of the merit of our products, our sales will decline and we will be unable to increase or achieve and sustain growth or profitability.

There is a learning process involved for spine surgeons to become proficient in the use of our products. Although most spine surgeons may have adequate knowledge on how to use most of our products based on their clinical training and experience, we believe that the most effective way to introduce and build market demand for our products is by directly training spine surgeons in the use of our products. If surgeons are not properly trained, they may misuse or ineffectively use our products. This may also result in unsatisfactory patient outcomes, patient injury, negative publicity or lawsuits against us, any of which could have a significant adverse effect on our business, financial condition and results of operations.

We must retain the current distributors of our products and attract new distributors of our products.

We plan to increase our network of independent distributors. The establishment and development of a broader distribution network may be expensive and time consuming. Because of the intense competition for their services, we may be unable to recruit or retain additional qualified independent distributors. Often, our competitors enter into distribution agreements with independent distributors that require such distributors to exclusively sell the products of our competitors. Further, we may not be able to enter into agreements with independent distributors on commercially reasonable terms, if at all. Even if we do enter into agreements with additional independent distributors, it often takes 90 to 120 days for new distributors to reach full operational effectiveness and such distributors may not generate revenue as quickly as we expect them to, commit the necessary resources to effectively market and sell our products or ultimately be successful in selling our products. Our business, financial condition and results of operations will be materially adversely affected if we do not retain our existing independent distributors and attract new, additional independent distributors or if the marketing and sales efforts of our independent distributors and our own direct sales representatives are unsuccessful.

We rely on a limited number of third parties to manufacture and supply our products. Any problems experienced by any of these manufacturers could result in a delay or interruption in the supply of our products to us until such manufacturer cures the problem or until we locate and qualify an alternative source of supply.

We rely on third party suppliers for the manufacture of our implants and instruments. We currently rely on a limited number of third party suppliers and any prolonged disruption in the operations of our third party suppliers could have a significant negative impact on our ability to supply our products to customers and to perform our obligations under the Supply Agreement with Globus, and would cause us to seek additional third-party manufacturing contracts, which may not be available on acceptable terms, if at all. We may suffer losses as a result of business interruptions that exceed coverage under our manufacturer’s insurance policies. Events beyond our control, such as natural disasters, fire, sabotage or business accidents could have a significant negative impact on our operations by disrupting our product development and commercialization efforts until such third-party supplier can repair its facility or put in place third-party contract manufacturers to assume this manufacturing role, which we may not be able to do on reasonable terms, if at all. In addition, if we are required to change manufacturers for any reason, we will be required to verify that the new manufacturer maintains facilities and procedures that comply with quality standards and with all applicable regulations and guidelines. The delays associated with the verification of a new manufacturer or the re-verification of an existing manufacturer could negatively affect our ability to develop products or supply products to customers in a timely manner. Any disruption in the manufacture of our products by our third party suppliers could have a material adverse impact on our business, financial condition and results of operations.

We depend on various third-party suppliers, and in one case a single third-party supplier, for key raw materials used in the manufacturing processes for our products and the loss of any of these third-party suppliers, or their inability to supply us with adequate raw materials, could harm our business.

We use a number of raw materials, including titanium, titanium alloys, stainless steel, PEEK, and human tissue. We rely from time to time on a number of suppliers and in one case on a single source vendor, Invibio. We have a supply agreement with Invibio, pursuant to which it supplies us with PEEK, a biocompatible plastic that we use in some of our spacers. Invibio is one of a limited number of companies approved to distribute PEEK in the U.S. for use in implantable devices. During 2016 and 2015, approximately 20% of our revenues were derived from products manufactured using PEEK.

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We depend on a limited number of sources of human tissue for use in our biologics products, and any failure to obtain tissue from these sources or to have the tissue processed by these entities for us in a timely manner will interfere with our ability to meet demand for our biologics products effectively. The processing of human tissue into biologics products is labor intensive and it is therefore difficult to maintain a steady supply stream. In addition, due to seasonal changes in mortality rates, some scarce tissues used for our biologics products are at times in particularly short supply. We cannot be certain that our supply of human tissue from our current suppliers and our current inventory of biologics products will be available at current levels or will be sufficient to meet our needs.

Our dependence on a single third-party PEEK supplier and the challenges we may face in obtaining adequate supplies of biologics products involve several risks, including limited control over pricing, availability, quality and delivery schedules. In addition, any supply interruption in a limited or sole sourced component or raw material, such as PEEK or human tissue, could materially harm the ability of our third party manufacturers to manufacture our products until a new source of supply, if any, could be found. We may be unable to find a sufficient alternative supply channel in a reasonable time period or on commercially reasonable terms, if at all, which would have a significant adverse effect on our business, financial condition and results of operations.

Our tissue-based products and related technologies could become subject to significantly greater regulation by the FDA, which could disrupt our business.

The FDA regulates human cells, tissues, and cellular and tissue-based products or HCT/Ps, but the extent to which they are regulated depends on how they are manufactured and used and whether they meet other criteria for minimal regulation. These criteria include but are not limited to the use of the HCT/Ps for homologous use only and minimal manipulation of the HCT/Ps. These HCT/Ps are regulated by the FDA solely under Section 361 of the Public Health Service Act and are referred to as “Section 361 HCT/Ps,” while other HCT/Ps are subject to FDA’s regulatory requirements applicable to medical devices or biologics. Section 361 HCT/Ps do not require 510(k) clearance, PMA approval, licensure of a biologics license application, or BLA, or other premarket authorization from FDA before marketing. We believe our HCT/Ps are regulated solely under Section 361 of the PHSA, and therefore, we have not sought or obtained 510(k) clearance, PMA approval, or licensure through a BLA. The FDA could disagree with our determination that our tissue-based products are Section 361 HCT/Ps and could determine that these products are biologics requiring a BLA or medical devices requiring 510(k) clearance or PMA approval, and could require that we cease marketing such products and/or recall them pending appropriate clearance, approval or license from the FDA. If the FDA determines that any of our current or future products contain HCT/Ps that do not meet the criteria for regulation as a Section 361 HCT/P, it could subject some of our products to additional review and regulatory oversight. If this were to happen, further distribution of the affected products could be interrupted for a substantial period of time, which would reduce our revenues and hurt our profitability.

If we or our suppliers fail to comply with the FDA’s quality system and good tissue practice regulations, the manufacture of our products could be delayed.

We and our suppliers are required to comply with the FDA’s QSR, which covers, among other things, the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, record keeping, storage and shipping of our products. In addition, suppliers and processors of products derived from HCT must comply with the FDA’s current good tissue practice requirements, or cGTPs, which govern the methods used in and the facilities and controls used for the manufacture of HCT/Ps, record keeping and the establishment of a quality program. The FDA audits compliance with the QSR and cGTPs through inspections of manufacturing and other facilities. If we or our suppliers have significant non-compliance issues or if any corrective action plan is not sufficient, we or our suppliers could be forced to halt the manufacture of our products until such problems are corrected to the FDA’s satisfaction, which could have a material adverse effect on our business, financial condition and results of operations. Further, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective. Any recall or FDA requirement demanding that we seek additional approvals or clearances could result in delays, costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA, all of which could have a material adverse effect on our business, financial condition and results of operations.

On July 17, 2015, Alphatec Spine, Inc., our wholly owned subsidiary, received a Warning Letter from the FDA in connection with the FDA’s inspection of our manufacturing facilities located in Carlsbad, California that occurred from February 4, 2015 until March 13, 2015, or the Inspection. In the Warning Letter, the FDA cited eight deficiencies in our responses to investigator's observations on the FDA Form 483, which was issued to us at the end of the Inspection. The deficiencies relate to our internal procedures for quality planning, design control, document control and corrective and preventive actions. The Warning Letter does not restrict production or shipment of our products from our facilities, or the sale or marketing of our products. On November 16, 2015, we responded to the FDA regarding the deficiencies set forth in the Warning Letter.  We believe we have effectively addressed the FDA concerns in the Warning Letter, but are awaiting an inspection or other response from the FDA to validate our resolution of such deficiencies.  Until the resolution of the deficiencies set forth in the Warning Letter are validated by the FDA, we may be subject to additional regulatory action by the FDA, and any such actions could significantly disrupt our ongoing business and operations and have a material adverse impact on our financial position and operating results.  There can be no assurance that the FDA will be satisfied with our response or proposed resolutions.

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Healthcare policy changes, including recent federal legislation to reform the U.S. healthcare system, may have a material adverse effect on us.

In response to perceived increases in health care costs in recent years, there have been and continue to be proposals by the federal government, state governments, regulators and third-party payors to control these costs and, more generally, to reform the U.S. healthcare system. Certain of these proposals could limit the prices we are able to charge for our products or the amounts of reimbursement available for our products, limit the acceptance and availability of our products, and have a material adverse effect on our financial position and results of operations. An expansion in government’s role in the U.S. healthcare industry may lower reimbursements for procedures using our products, reduce medical procedure volumes and adversely affect our business and results of operations, possibly materially.

The demand for products and the prices at which customers and patients are willing to pay for our products depend upon the ability of our customers to obtain adequate third-party coverage and reimbursement for their purchases of our products.

Sales of our products depend in part on the availability of adequate coverage and reimbursement from governmental and private payors. In the U.S., healthcare providers that purchase our products generally rely on third-party payors, principally Medicare, Medicaid and private health insurance plans, to pay for all or a portion of the costs and fees associated with the use of our products. In addition, several million individuals were able to purchase health insurance in 2014 for the first time through health insurance "exchanges" established under the ACA. While procedures using our currently marketed products are eligible for reimbursement in the U.S., if surgical procedures utilizing our products are performed on an outpatient basis, it is possible that private payors may no longer provide reimbursement for the procedures using our products without further supporting data on the procedure. Any delays in obtaining, or an inability to obtain, adequate coverage or reimbursement for procedures using our products could significantly affect the acceptance of our products and have a significant adverse effect on our business. Additionally, third-party payors continue to review their coverage policies carefully for existing and new therapies and can, without notice, deny coverage for treatments that include the use of our products. Our business would be negatively impacted if there are any changes that reduce reimbursement for our products.

Furthermore, healthcare costs have risen significantly over the past decade. There have been and may continue to be proposals by legislators, regulators and third-party payors to contain these costs. Several such proposals were enacted as part of ACA, and include numerous provisions to limit Medicare spending through reductions in various fee schedule payments and sweeping payment reforms. Other federal and state cost-control measures include prospective payment systems, capitated rates, group purchasing, redesign of benefits, requiring pre-authorizations or second opinions prior to major surgery, encouragement of healthier lifestyles and exploration of more cost-effective methods of delivering healthcare. Some healthcare providers in the U.S. have adopted or are considering a managed care system in which the providers contract to provide comprehensive healthcare for a fixed cost per person. Healthcare providers may also attempt to control costs by authorizing fewer elective surgical procedures or by requiring the use of the least expensive devices possible. These cost-control methods also potentially limit the amount which healthcare providers may be willing to pay for medical devices. In addition, in the U.S., no uniform policy of coverage and reimbursement for medical technology exists among all these payors. Therefore, coverage of and reimbursement for medical technology can differ significantly from payor to payor. The continuing efforts of third-party payors, whether governmental or commercial, whether inside or outside the U.S., to contain or reduce these costs, combined with closer scrutiny of such costs, could restrict our customers’ ability to obtain adequate coverage and reimbursement from these third-party payors. The cost containment measures contained in ACA and other measures being considered at the federal and state level, as well as internationally, could harm our business by adversely affecting the demand for our products or the price at which we can sell our products.

Consolidation in the healthcare industry could lead to demands for price concessions or to the exclusion of some suppliers from certain of our markets, which could have an adverse effect on our business, financial condition or results of operations.

Because healthcare costs have risen significantly over the past decade, numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the healthcare industry to create new companies with greater market power, including hospitals. As the healthcare industry consolidates, competition to provide products and services to industry participants has become and will continue to become more intense. This in turn has resulted and will likely continue to result in greater pricing pressures and the exclusion of certain suppliers from important market segments as group purchasing organizations, independent delivery networks and large single accounts continue to use their market power to consolidate purchasing decisions for some of our customers. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to change the worldwide healthcare industry, resulting in further business consolidations and alliances among our customers, which may reduce competition, exert further downward pressure on the prices of our products and may adversely impact our business, financial condition or results of operations.

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We may be subject to or otherwise affected by federal and state healthcare laws, including fraud and abuse, health information privacy and security, and disclosure laws, and could face substantial penalties if we are unable to fully comply with such laws.

Although we do not provide healthcare services, submit claims for third-party reimbursement, or receive payments directly from Medicare, Medicaid, or other third-party payors for our products or the procedures in which our products are used, healthcare regulation by federal and state governments significantly impacts our business. Healthcare fraud and abuse, health information privacy and security, and disclosure laws potentially applicable to our operations include:

 

the federal Anti-Kickback Statute, as well as state analogs, which constrains our marketing practices and those of our independent sales agents and distributors, educational programs, pricing policies, and relationships with healthcare providers by prohibiting, among other things, knowingly and willfully soliciting, receiving, offering or providing remuneration, intended to induce the purchase or recommendation of an item or service reimbursable under a federal (or state or commercial) healthcare program (such as the Medicare or Medicaid programs);

 

the federal ban, as well as state analogs, on physician self-referrals, which prohibits, subject to certain exceptions, physician referrals of Medicare and Medicaid patients to an entity providing certain “designated health services” if the physician or an immediate family member of the physician has any financial relationship with the entity;

 

federal false claims laws which prohibit, among other things, knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent;

 

HIPAA, and its implementing regulations, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;

 

the state and federal laws “sunshine” provisions that require detailed reporting and disclosures to CMS and applicable states of any payments or “transfer of value” made or distributed to prescribers and other health care providers, and for certain states prohibit some forms of these payments, require the adoption of marketing codes of conduct, require the reporting of marketing expenditures and pricing information and constrain relationships with physicians and other referral sources;

 

state laws analogous to each of the above federal laws, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of certain health information, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts;

 

the Administrative Simplification provisions of HIPAA, specifically, privacy and security provisions including recent amendments under HITECH which impose stringent restrictions on uses and disclosures of protected health information such as for marketing or clinical research purposes and impose significant civil and criminal penalties for non-compliance and require the reporting of breaches to affected individuals, the government and in some cases the media in the event of a violation; and

 

a variety of state-imposed privacy and data security laws which require the protection of information beyond health information, such as employee information or any class of information combining name with state issued identification numbers, social security numbers, credit card, bank or other financial information and which require reporting to state officials in the event of breach or violation and which impose both civil and criminal penalties.

ACA includes various provisions designed to strengthen significantly fraud and abuse enforcement, such as increased funding for enforcement efforts and the lowering of the intent requirement of the federal Anti-Kickback Statute and criminal healthcare fraud statute such that a person or entity no longer needs to have actual knowledge of these statutes or specific intent to violate them.

If our past or present operations, or those of our independent sales agents and distributors are found to be in violation of any of such laws or any other governmental regulations that may apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from federal healthcare programs and/or the curtailment or restructuring of our operations. Similarly, if the healthcare providers, sales agents, distributors or other entities with which we do business are found to be non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the Courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against them, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

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The sales and marketing practices of our industry have been the subject of increased scrutiny from federal and state government agencies, and we believe that this trend will continue. For example, on March 26, 2013 the OIG issued a Special Fraud Alert entitled "Physician-Owned Entities" related to physician-owned distributors, or PODS. Since 2013, the OIG has further increased its scrutiny of PODs and the Department of Justice has brought several high profile cases against physician owners. Prosecutorial scrutiny and governmental oversight over some major device companies regarding the retention of healthcare professionals as consultants has affected and may continue to affect the manner in which medical device companies may retain healthcare professionals as consultants. Any precautions we take to detect and prevent noncompliance with applicable laws may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to comply with these laws or regulations. Any action against us for violation of these laws, even if we successfully defend against them, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

If we fail to obtain, or experience significant delays in obtaining, FDA clearances or approvals for our future products or modifications to our products, our ability to commercially distribute and market our products could suffer.

Our medical devices are subject to extensive regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory clearances or approvals to market a medical device, particularly from the FDA, can be costly and time consuming, and there can be no assurance that such clearances or approvals will be granted on a timely basis, if at all. In particular, the FDA permits commercial distribution of most new medical devices only after the devices have received clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, or 510(k), or are the subject of an approved premarket approval application, or a PMA. The 510(k) process generally takes three to nine months, but can take significantly longer, especially if the FDA requires a clinical trial to support the 510(k) application.  Currently, we do not know whether the FDA will require clinical data in support of any 510(k)s that we intend to submit for other products in our pipeline. In addition, the FDA continues to re-examine its 510(k) clearance process for medical devices and published several draft guidance documents that could change that process. Any changes that make the process more restrictive could increase the time it takes for us to obtain clearances or could make the 510(k) process unavailable for certain of our products. A PMA must be submitted to the FDA if the device cannot be cleared through the 510(k) process or is not exempt from premarket review by the FDA. A PMA must be supported by extensive data, including results of preclinical studies and clinical trials, manufacturing and control data and proposed labeling, to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use. The PMA process is more costly and uncertain than the 510(k) clearance process, and generally takes between one and three years, if not longer. In addition, any modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design or manufacture, requires a new 510(k) clearance or, possibly, a PMA.

Modifications to products that are approved through a PMA application generally need FDA approval. Similarly, some modifications made to products cleared through a 510(k) may require a new 510(k).  Our commercial distribution and marketing of any products or product modifications that we develop will be delayed until regulatory clearance or approval is obtained. In addition, because we cannot assure you that any new products or any product modifications we develop will be subject to the shorter 510(k) clearance process, the regulatory approval process for our new products or product modifications may take significantly longer than anticipated. There is no assurance that the FDA will not require a new product or product modification to go through the lengthy and expensive PMA approval process. The FDA can delay, limit or deny clearance or approval of a device for many reasons, including:

 

our inability to demonstrate to the satisfaction of the FDA or the applicable regulatory entity or notified body that our products are safe or effective for their intended uses;

 

the disagreement of the FDA or the applicable foreign regulatory body with the design or implementation of our clinical trials or the interpretation of data from pre-clinical studies or clinical trials;

 

serious and unexpected adverse device effects experienced by participants in our clinical trials;

 

the data from our pre-clinical studies and clinical trials may be insufficient to support clearance or approval, where required;

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our inability to demonstrate that the clinical and other benefits of the device outweigh the risks;

 

the manufacturing process or facilities we use may not meet applicable requirements; or

 

the potential for approval policies or regulations of the FDA or applicable foreign regulatory bodies to change significantly in a manner rendering our clinical data or regulatory filings insufficient for clearance or approval.

Delays in obtaining regulatory clearances and approvals may:

 

delay or prevent commercialization of products we develop;

 

require us to perform costly tests or studies;

 

diminish any competitive advantages that we might otherwise have obtained; and

 

reduce our ability to collect revenues.

To date, all of our non-biologic medical device products that have required FDA review that are being sold in the U.S. have been cleared through the 510(k) process without any required clinical trials. However, the FDA may require clinical data in support of any future 510(k)s or PMAs that we intend to submit for products in our pipeline. We have limited experience in performing clinical trials that might be required for a 510(k) clearance or PMA approval. If any of our products require clinical trials, the commercialization of such products could be delayed which could have a material adverse effect on our business, financial condition and results of operations.

The safety of our products is not yet supported by long-term clinical data and may therefore prove to be less safe and effective than initially thought.

We obtained clearance to offer all of our current non-biologic medical device products through the 510(k) route. The ability to obtain a 510(k) clearance is generally based on the FDA’s agreement that a new product is substantially equivalent to certain already marketed products. Because most 510(k)-cleared products were not the subject of pre-market clinical trials, surgeons may be slow to adopt our 510(k)-cleared products, we may not have the comparative data that our competitors have or are generating, and we may be subject to greater regulatory and product liability risks. With the passage of the American Recovery and Reinvestment Act of 2009, funds have been appropriated for the U.S. Department of Health and Human Services’ Healthcare Research and Quality to conduct comparative effectiveness research to determine the effectiveness of different drugs, medical devices, and procedures in treating certain conditions and diseases. Some of our products or procedures performed with our products could become the subject of such research. It is unknown what effect, if any, this research may have on our business. Further, future research or experience may indicate that treatment with our products does not improve patient outcomes or improves patient outcomes less than we initially expect. Such results would reduce demand for our products and this could cause us to withdraw our products from the market. Moreover, if future research or experience indicate that our products cause unexpected or serious complications or other unforeseen negative effects, we could be subject to significant legal liability, significant negative publicity, damage to our reputation and a dramatic reduction in sales of our products, all of which would have a material adverse effect on our business, financial condition and results of operations.

Failure to comply with post-marketing regulatory requirements could subject us to enforcement actions, including substantial penalties, and might require us to recall or withdraw a product from the market.

Once a medical device is cleared or approved, a manufacturer must notify the FDA of any modifications to the device. Any modification to a device that has received FDA clearance that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design or manufacture, requires premarket clearance or possibly approval of a PMA. The FDA requires every manufacturer to make the determination in the first instance regarding whether a modification to a cleared or approved device necessitates the filing of a new 510(k) notification or PMA supplement. The FDA may review any manufacturer's decision and can disagree. If the FDA disagrees with any future determination by us that a new clearance or approval is not required, we may need to cease marketing or to recall the modified product until and unless we obtain clearance or approval. In addition, we could also be subject to significant regulatory fines or penalties. Any of these outcomes would harm our business.

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The regulations to which we are subject are complex and have become more stringent over time. Regulatory changes could result in restrictions on our ability to continue or expand our operations, higher than anticipated costs, or lower than anticipated sales. Even after we have obtained the proper regulatory clearance or approval to market a product, we have ongoing responsibilities under FDA regulations and applicable foreign laws and regulations. The FDA’s and other regulatory authorities’ policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approval of our product candidates. For example, in December 2016, the 21st Century Cures Act, or Cures Act, was signed into law.  The Cures Act, among other things, is intended to modernize the regulation of devices and spur innovation, but its ultimate implementation is unclear. The FDA, state and foreign regulatory authorities have broad enforcement powers. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may be subject to enforcement action by the FDA, state or foreign regulatory authorities, which may include any of the following sanctions:

 

untitled letters or warning letters;

 

fines, injunctions, consent decrees and civil penalties;

 

recalls, termination of distribution, administrative detention, or seizure of our products;

 

customer notifications or repair, replacement or refunds;

 

operating restrictions or partial suspension or total shutdown of production;

 

delays in or refusal to grant our requests for future 510(k) clearances, PMA approvals or foreign regulatory approvals of new products, new intended uses, or modifications to existing products;

 

withdrawals or suspensions of current 510(k) clearances or PMAs or foreign regulatory approvals, resulting in prohibitions on sales of our products;

 

FDA refusal to issue certificates to foreign governments needed to export products for sale in other countries; and/ or

 

criminal prosecution.

Any of these sanctions could result in higher than anticipated costs or lower than anticipated sales and have a material adverse effect on our reputation, business, results of operations and financial condition.

We also cannot predict the likelihood, nature or extent of government regulation that may arise from future legislation or administrative or executive action, either in the United States or abroad.  For example, certain policies of the new Presidential administration may impact our business and industry.  Namely, the new Presidential administration has taken several executive actions, including the issuance of a number of Executive Orders, that could impose significant burdens on, or otherwise materially delay, FDA’s ability to engage in routine regulatory and oversight activities such as implementing statutes through rulemaking, issuance of guidance, and review and approval of marketing applications.  Notably, on January 23, 2017, the new Presidential administration ordered a hiring freeze for all executive departments and agencies, including the FDA, which prohibits the FDA from filling employee vacancies or creating new positions.  Under the terms of the order, the freeze will remain in effect until implementation of a plan to be recommended by the Director for the Office of Management and Budget, or OMB, in consultation with the Director of the Office of Personnel Management, to reduce the size of the federal workforce through attrition. An under-staffed FDA could result in delays in FDA’s responsiveness or in its ability to review submissions or applications, issue regulations or guidance, or implement or enforce regulatory requirements in a timely fashion or at all.  Moreover, on January 30, 2017, the new Presidential administration issued an Executive Order, applicable to all executive agencies, including the FDA, that requires that for each notice of proposed rulemaking or final regulation to be issued in fiscal year 2017, the agency shall identify at least two existing regulations to be repealed, unless prohibited by law.  These requirements are referred to as the “two-for-one” provisions. This Executive Order includes a budget neutrality provision that requires the total incremental cost of all new regulations in the 2017 fiscal year, including repealed regulations, to be no greater than zero, except in limited circumstances.  For fiscal years 2018 and beyond, the Executive Order requires agencies to identify regulations to offset any incremental cost of a new regulation and approximate the total costs or savings associated with each new regulation or repealed regulation.  In interim guidance issued by the Office of Information and Regulatory Affairs within OMB on February 2, 2017, the administration indicates that the “two-for-one” provisions may apply not only to agency regulations, but also to significant agency guidance documents.  In addition, on February 24, 2017, the new Presidential administration issued an executive order directing each affected agency to designate an agency official as  a “Regulatory Reform Officer” and establish  a “Regulatory Reform Task Force” to implement the two-for-one provisions and other previously issued executive orders relating to the review of federal regulations, however it is difficult to predict how these requirements will be implemented, and the extent to which they will impact the FDA’s ability to exercise its regulatory authority.  If these executive actions impose constraints on FDA’s ability to engage in oversight and implementation activities in the normal course, our business may be negatively impacted.

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If we choose to acquire new and complementary businesses, products or technologies, we may be unable to complete these acquisitions or successfully integrate them in a cost-effective and non-disruptive manner.

Our success depends in part on our ability to continually enhance and broaden our product offering in response to changing customer demands, competitive pressures and technologies and our ability to increase our market share. Accordingly, we have pursued and intend to pursue the acquisition of complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to successfully complete any acquisitions, or whether we will be able to successfully integrate any acquired business, product or technology into our business or retain any key personnel, suppliers or distributors. Our ability to successfully grow through acquisitions depends upon our ability to identify, negotiate, complete and integrate suitable acquisitions and to obtain any necessary financing. These efforts could be expensive and time consuming, disrupt our ongoing business and distract management. If we are unable to integrate any future or recently acquired businesses, products or technologies effectively, our business, financial condition and results of operations will be materially adversely affected. For example, an acquisition could materially impair our operating results by causing us to incur debt or requiring us to amortize significant amounts of expenses, including non-cash acquisition costs, and acquired assets.

We may not be able to timely develop new products or product enhancements that will be accepted by the market.

We sell our products in a market that is characterized by technological change, product innovation, evolving industry standards, competing patent claims, patent litigation and intense competition. Our success will depend in part on our ability to develop and introduce new products and enhancements or modifications to our existing products, which we will need to do before our competitors do so and in a manner that does not infringe issued patents of third parties from which we do not have a license. We cannot assure you that we will be able to successfully develop or market new, improved or modified products, or that any of our future products will be accepted by even the surgeons who use our current products. Our competitors’ product development capabilities could be more effective than our capabilities, and their new products may get to market before our products. In addition, the products of our competitors may be more effective or less expensive than our products. The introduction of new products by our competitors may lead us to have price reductions, reduced margins or loss of market share and may render our products obsolete or noncompetitive. The success of any of our new product offerings or enhancement or modification to our existing products will depend on several factors, including our ability to:

 

properly identify and anticipate surgeon and patient needs;

 

develop new products or enhancements in a timely manner;

 

obtain the necessary regulatory approvals for new products or product enhancements;

 

provide adequate training to potential users of new products;

 

receive adequate reimbursement approval of third-party payors such as Medicaid, Medicare and private insurers; and

 

develop an effective marketing and distribution network.

Developing products in a timely manner can be difficult, in particular because product designs change rapidly to adjust to third-party patent constraints and to market preferences. As a result, we may experience delays in our product launches which may significantly impede our ability to enter or compete in a given market and may reduce the sales that we are able to generate from these products. We may experience delays in any phase of a product launch, including during research and development, clinical trials, manufacturing, marketing and the surgeon training process. In addition, our suppliers of products or components can suffer similar delays, which could cause delays in our product introductions. If we do not develop new products or product enhancements in time to meet market demand or if there is insufficient demand for these new products or enhancements, it could have a significant adverse effect on our business financial condition and results of operations.

We are dependent on our senior management team, sales and marketing team, engineering team and key surgeon advisors, and the loss of any of them could harm our business.

Our continued success depends in part upon the continued availability and contributions of our senior management, sales and marketing team and engineering team and the continued participation of our key surgeon advisors. While we have entered into employment agreements with all members of our senior management team, none of these agreements guarantees the services of the individual for a specified period of time. We would be adversely affected if we fail to adequately prepare for future turnover of our senior management team. Our ability to grow or at least maintain our sales levels depends in large part on our ability to attract and retain sales and marketing personnel and for these sales people to maintain their relationships with surgeons directly and through our distributors. We rely on our engineering team to research, design and develop potential products for our product pipeline. We also rely on our surgeon advisors to advise us on our products, our product pipeline, long-term scientific planning, research and development and industry trends. We compete for personnel and advisors with other companies and other organizations, many of which are larger and have greater name recognition and financial and other resources than we do. We recently implemented numerous changes in our

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management team, including in the roles of Chief Executive Officer, Chief Financial Officer, Executive Vice President, People & Culture, and General Counsel, which could have an adverse effect on our retention of our employees, advisors and distributors.  Changes to our senior management team, sales and marketing team, engineering team and key surgeon advisors, or our inability to attract or retain other qualified personnel or advisors, could have a significant adverse effect on our business, financial conditions and results of operations.

Compliance with laws and regulations and standards for accounting, corporate governance and public disclosure is time consuming and results in significant expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002,  The Dodd-Frank Wall Street Reform and Consumer Protection Act, other SEC regulations, NASDAQ Stock Market listing rules, and new accounting pronouncements create uncertainty and additional complexities for companies such as ours.  Our management and other personnel need to devote a substantial amount of time to these compliance initiatives.  Moreover these rules and regulations increase our legal and financial compliance costs and make some activities more time consuming and costly.  

If we fail to maintain effective internal controls and procedures for financial reporting, we could be unable to provide timely and accurate financial information and therefore be subject to delisting from The NASDAQ Global Select Market, an investigation by the SEC, and civil or criminal sanctions. Additionally, ineffective internal control over financial reporting would place us at increased risk of fraud or misuse of corporate assets and could cause our stockholders, lenders, suppliers and others to lose confidence in the accuracy or completeness of our financial reports.  This, in turn could adversely affect our ability to access the capital markets.

Security breaches, loss of data and other disruptions could compromise sensitive information related to our business, prevent us from accessing critical information or expose us to liability, which could adversely affect our business and our reputation.

In the ordinary course of our business, we collect and store sensitive data, including legally protected patient health information, credit card information, personally identifiable information about our employees, intellectual property, and proprietary business information. We manage and maintain our applications and data utilizing on-site systems. These applications and data encompass a wide variety of business critical information including research and development information, commercial information and business and financial information.

The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure may be vulnerable to attacks by hackers, viruses, breaches or interruptions due to employee error or malfeasance, terrorist attacks, earthquakes, fire, flood, other natural disasters, power loss, computer systems failure, data network failure, Internet failure, or lapses in compliance with privacy and security mandates. Any such attack, virus, breach or interruption could compromise our networks and the information stored there could be accessed by unauthorized parties, publicly disclosed, lost or stolen. We have measures in place that are designed to detect and respond to such security incidents and breaches of privacy and security mandates. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, such as HIPAA, government enforcement actions and regulatory penalties. Unauthorized access, loss or dissemination could also interrupt our operations, including our ability to bill our customers, provide customer support services, conduct research and development activities, process and prepare company financial information, manage various general and administrative aspects of our business and damage our reputation, any of which could adversely affect our business.

Nearly all of our operations are currently conducted in locations that may be at risk of damage from fire, earthquakes or other natural disasters.

We currently conduct nearly all of our development and management activities in Carlsbad, California near known wildfire areas and earthquake fault zones. We have taken precautions to safeguard our facilities, including obtaining property and casualty insurance, and implementing health and safety protocols. We have developed an information technology disaster recovery plan. However, any future natural disaster, such as a fire or an earthquake, could cause substantial delays in our operations, damage or destroy our equipment or inventory and cause us to incur additional expenses. A disaster could seriously harm our business, financial condition and results of operations. Our facilities would be difficult to replace and would require substantial lead time to repair or replace. The insurance we maintain against earthquakes, fires, and other natural disasters would not be adequate to cover a total loss of our facilities, may not be adequate to cover our losses in any particular case and may not continue to be available to us on acceptable terms, or at all.

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Alphatec Holdings is a holding company with no operations, and unless it receives dividends or other payments from its subsidiaries, it will be unable to fulfill its cash obligations.

As a holding company with no business operations, Alphatec Holdings’ material assets consist only of the common stock of its subsidiaries, including Alphatec Spine and Scient’x, dividends and other payments received from time to time from its subsidiaries, and the proceeds raised from the sale of debt and equity securities. Alphatec Holdings’ subsidiaries are legally distinct from Alphatec Holdings and have no obligation, contingent or otherwise, to make funds available to Alphatec Holdings. Alphatec Holdings will have to rely upon dividends and other payments from its subsidiaries to generate the funds necessary to fulfill its cash obligations. Alphatec Holdings may not be able to access cash generated by its subsidiaries in order to fulfill cash commitments. The ability of Alphatec Spine to make dividend and other payments to Alphatec Holdings is subject to the availability of funds after taking into account its subsidiaries’ funding requirements, the terms of its subsidiaries’ indebtedness and applicable state laws.

If we fail to properly manage our anticipated growth, our business could suffer.

We will continue to pursue growth in the number of surgeons using our products, the types of products we offer and the geographic regions where our products are sold. Such anticipated growth has placed and will continue to place significant demands on our managerial, operational and financial resources and systems. Future growth would impose significant added responsibilities on members of management, including the need to identify, recruit, maintain, motivate and integrate additional personnel. Also, our management may need to divert a disproportionate amount of its attention away from our day-to-day activities and devote a substantial amount of time to managing these anticipated growth activities. We are currently focused on increasing the size and effectiveness of our sales force and distribution network, marketing activities, research and development efforts, inventory management systems, management team and corporate infrastructure. If we do not manage our anticipated growth effectively, the quality of our products, our relationships with physicians, distributors and hospitals, and our reputation could suffer, which would have a significant adverse effect on our business, financial condition and results of operations. We must attract and retain qualified personnel and third-party distributors and manage and train them effectively. Personnel qualified in the design, development, production and marketing of our products are difficult to find and hire, and enhancements of information technology systems to support our growth are difficult to implement. We will also need to carefully monitor and manage our surgeon services, our third-party manufacturing resources, quality assurance and efficiency, and the quality assurance and efficiency of our suppliers and distributors. This managing, training and monitoring will require allocation of valuable management resources and significant expense. If our management is unable to effectively manage our expected growth, our expenses may increase more than expected, our ability to generate and/or grow revenues could be reduced and we may not be able to implement our business strategy.

Our announced workforce reduction may cause undesirable consequences and our results of operations may be harmed.

Since September 2016, we have reduced our workforce by approximately 30%. This workforce reduction may yield unintended consequences, such as attrition beyond our intended reduction in workforce and reduced employee morale, which may cause our employees who were not affected by the reduction in workforce to seek alternate employment. Additional attrition could impede our ability to meet our operational goals, which could have a material adverse effect on our financial performance. In addition, as a result of the reductions in our workforce, we may face an increased risk of employment litigation. Furthermore, employees whose positions will be eliminated in connection with these trends may seek future employment with our competitors. Although all our employees are required to sign a confidentiality agreement with us at the time of hire, we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. We cannot assure you that we will not undertake additional reduction activities, that any of our efforts will be successful, or that we will be able to realize the cost savings and other anticipated benefits from our previous or any future reduction plans. In addition, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to any new product, growth or revenue opportunities.

Risks Related to Our Financial Results, Credit and Certain Financial Obligations and Need for Financing

We may need to raise additional funds in the future and such funds may not be available on acceptable terms, if at all.

At December 31, 2016, our principal sources of liquidity consisted of cash of $19.6 million and accounts receivable, net of $18.5 million.  Together with the proceeds of our approximately $18.9 million private placement in March 2017, we currently estimate this will provide sufficient capital to fund our operations through at least the next 12 months.

We may seek additional funds from public and private equity or debt financings, borrowings under new debt facilities or other sources to fund our projected operating requirements. Our capital requirements will depend on many factors, including:

 

the payments due in connection with the settlement of the Orthotec matter;

 

the revenues generated by sales of our products;

 

the costs associated with expanding our sales and marketing efforts;

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the expenses that we incur from the manufacture of our products by third parties and that we incur from selling our products;

 

the costs of developing new products or technologies;

 

the cost of obtaining and maintaining FDA or other regulatory approval or clearance for our products and products in development;

 

the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;

 

the number and timing of acquisitions and other strategic transactions;

 

the costs and any payments we may make related to our pending litigation matters;

 

the costs associated with increased capital expenditures; and

 

the costs associated with our employee retention programs and related benefits.

As a result of these factors, we may need to raise additional funds and such funds may not be available on favorable terms, if at all. However, under the securities purchase agreement we entered into in March 2017 in connection with our private placement of common stock, Series A Convertible Preferred Stock and warrants to purchase common stock, or the March 2017 private placement, we are prohibited from issuing or entering into any agreement to issue any shares of our common stock or other securities, subject to certain permitted exceptions, until the later of (a) 90 days after the effective date of the resale registration statement we are required to file registering the resale of the shares of common stock issued or issuable in the private placement or (b) the date of stockholder approval of the March 2017 private placement.  In addition, rules and regulations of the SEC may restrict our ability to conduct certain types of financing activities, or may affect the timing of and the amounts we can raise by undertaking such activities. For example, under current SEC regulations, at any time during which the aggregate market value of our common stock held by non-affiliates, or our public float, is less than $75 million, the amount that we can raise through primary public offerings of securities in any twelve-month period using one or more registration statements on Form S-3 will be limited to an aggregate of one-third of our public float. As of March 29, 2017, our public float was $26 million.  

In addition, upon the effectiveness of the resale registration statement we are required to file as part of the March 2017 private placement, all of the 1,809,628 shares of common stock, 7,622,372 shares of common stock issuable upon the conversion of an aggregate of approximately 15,245 shares of our Series A Convertible Preferred Stock and 9,432,000 shares of common stock issuable upon exercise of warrants issued in the March 2017 private placement will become available for resale to the public, which will result in dilution to our existing stockholders.  In addition, if we fail to meet the specified filing deadlines for such resale registration statement or maintain its effectiveness or do not comply with the current public information requirements to allow resales of the shares pursuant to Rule 144 under the Securities Act,  in each case subject to certain permitted exceptions, we may be required to pay liquidated damages to the purchasers in the private placement, in amount of 1.5% of the original subscription amount per month, subject to an aggregate maximum of 12% per calendar year in the case of the effectiveness of the resale registration statement.

Furthermore, if we issue additional equity or debt securities to raise additional funds, our existing stockholders may experience dilution and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our potential products or proprietary technologies, or to grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to repay debt or other liabilities, develop or enhance our products, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. Any of these events could adversely affect our ability to achieve our development and commercialization goals and have a significant adverse effect on our business, financial condition and results of operations.

If we default on our obligations to make settlement payments to Orthotec LLC, the amounts due under the settlement agreements accelerate and become due and payable.

Any default of our payment obligation under the settlement agreements we entered into with Orthotec LLC, or Orthotec, would give Orthotec the right to declare all of the future payments to be immediately payable. As of March 17, 2017, the outstanding amount to be paid to Orthotec through January 2024 is $30.4 million. If acceleration of payments occurs, our business, financial condition and results of operations could be materially and adversely affected.

 

 

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We have a history of net losses, we expect to continue to incur net losses in the near future, and we may not achieve or maintain profitability.

 

We have typically incurred net losses from our continuing operations since our inception. As of December 31, 2016, we had an accumulated deficit of $457.2 million. We have incurred significant net losses since inception and have relied on our ability to fund our operations through revenues from the sale of our products, equity financings and debt financings. As we have incurred losses, successful transition to profitability is dependent upon achieving a level of revenues adequate to support our cost structure. This may not occur and, unless and until it does, we will continue to need to raise additional capital.  We may seek additional funds from public and private equity or debt financings, borrowings under new debt facilities or other sources to fund our projected operating requirements.  However, there is no guarantee that we will be able to obtain further financing, or do so on reasonable terms. If we are unable to raise additional funds on a timely basis, or at all, we would be materially adversely affected.

 

We may be unable to comply with the covenants of our credit facilities.

We must comply with certain affirmative and negative covenants, including financial covenants, in our Amended Credit Facility and affirmative and negative covenants under the Globus Facility Agreement. We failed to comply with the fixed charge coverage ratio for January and June 2016, the fixed charge coverage ratio, senior leverage ratio and total leverage ratio covenants for March 2016, and the fixed charge coverage ratio and total leverage ratio covenants for April and May 2016, under our Amended Credit Facility. We also did not meet a minimum requirement for the percentage of our total cash held in U.S. accounts for January, February, March, April, May and June 2016. MidCap and Deerfield, pursuant to the Deerfield Facility Agreement which has been terminated, provided waivers with respect to our non-compliance during such periods. There can be no assurance that at all times in the future we will satisfy all such financial or other covenants of the Amended Credit Facility or the Globus Facility Agreement, or obtain any required waiver or amendment, in which event of default the lenders party to the Amended Credit Facility could refuse to make further extensions of credit to us and MidCap and/or Globus could require all amounts borrowed under the Amended Credit Facility and/or the Globus Facility Agreement, respectively, together with accrued interest and other fees, to be immediately due and payable. In addition to allowing the lenders to accelerate the loan, several events of default under the Amended Credit Facility or Globus Facility Agreement, such as our failure to make required payments of principal and interest and the occurrence of certain bankruptcy or insolvency events, could require us to pay interest at a rate which is up to five percentage points higher than the interest rate effective immediately before the event of default.

An event of default under the Amended Credit Facility or the Globus Facility Agreement could have a material adverse effect on us. Upon an event of default, if the lenders under the Amended Credit Facility or Globus Facility Agreement accelerate the repayment of all amounts borrowed, together with accrued interest and other fees, or if the lenders elect to charge us additional interest, we cannot assure you that we will have sufficient cash available to repay the amounts due, and we may be forced to seek to amend the terms of the Amended Credit Facility or the Globus Facility Agreement or obtain alternative financing, which may not be available to us on acceptable terms, if at all.

In addition, if we fail to pay amounts when due under the Amended Credit Facility or the Globus Facility Agreement or upon the occurrence of another event of default, the lenders under the Amended Credit Facility or the Globus Facility Agreement could proceed against the collateral granted to them pursuant to the MidCap Amended Credit Facility and the Globus Facility Agreement. We have granted to the lenders under the Amended Credit Facility a first priority security interest in substantially all of our assets, including all accounts receivable and all securities evidencing our interests in our subsidiaries, as collateral under the Amended Credit Facility. We have granted Globus under the Globus Facility Agreement a first lien security interest in substantially all of our assets, other than accounts receivable and related assets, which will secure the Globus Facility Agreement on a second lien basis. If Globus proceeds against the collateral, such assets would no longer be available for use in our business, which would have a significant adverse effect our business, financial condition and results of operations.

Our quarterly financial results could fluctuate significantly.

Our quarterly financial results are difficult to predict and may fluctuate significantly from period to period, particularly because our sales prospects are uncertain. The level of our revenues and results of operations at any given time will be based primarily on the following factors:

 

acceptance of our products by surgeons, patients, hospitals and third-party payors;

 

demand and pricing of our products;

 

the mix of our products sold, because profit margins differ among our products;

 

timing of new product offerings, acquisitions, licenses or other significant events by us or our competitors;

 

our ability to grow and maintain a productive sales and marketing organization and independent distributor network;

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regulatory approvals and legislative changes affecting the products we may offer or those of our competitors;

 

the effect of competing technological and market developments;

 

levels of third-party reimbursement for our products;

 

interruption in the manufacturing or distribution of our products;

 

our ability to produce or obtain products of satisfactory quality or in sufficient quantities to meet demand; and

 

changes in our ability to obtain FDA, state and international approval or clearance for our products.

In addition, until we have a larger base of surgeons using our products, occasional fluctuations in the use of our products by individual surgeons or small groups of surgeons will have a proportionately larger impact on our revenues than for companies with a larger customer base.

Many of the products we may seek to develop and introduce in the future will require FDA approval or clearance. We cannot begin to commercialize any such products in the U.S. without FDA approval or clearance. As a result, it will be difficult for us to forecast demand for these products with any degree of certainty. We cannot assure you that our revenue will increase or be sustained in future periods or that we will be profitable in any future period. Any shortfalls in revenue or earnings from levels expected by our stockholders or by securities or industry analysts could have an immediate and significant adverse effect on the trading price of our common stock in any given period.

Risks Related to Our Intellectual Property Regulatory Penalties and Potential Litigation

If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and be unable to operate our business profitably.

Our success depends significantly on our ability to protect our proprietary rights of the technologies used in our products. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example, we cannot assure you that any of our pending patent applications will result in the issuance of patents to us. The U.S. Patent and Trademark Office, or PTO, may deny or require significant narrowing of claims in our pending patent applications, and patents issued as a result of the pending patent applications, if any, may not provide us with significant commercial protection or be issued in a form that is advantageous to us. We could also incur substantial costs in proceedings before the PTO. These proceedings could result in adverse decisions as to the priority of our inventions and the narrowing or invalidation of claims in issued patents. Our issued patents and those that may be issued in the future could subsequently be successfully challenged by others and invalidated or rendered unenforceable, which could limit our ability to stop competitors from marketing and selling related products. In addition, our pending patent applications include claims to aspects of our products and procedures that are not currently protected by issued patents.

Both the patent application process and the process of managing patent disputes can be time consuming and expensive. Competitors may be able to design around our patents or develop products that provide outcomes that are comparable to our products but fall outside of the scope of our patent protection. Although we have entered into confidentiality agreements and intellectual property assignment agreements with certain of our employees, consultants and advisors as one of the ways we seek to protect our intellectual property and other proprietary technology, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements. In the event a competitor infringes upon one of our patents or other intellectual property rights, enforcing those patents and rights may be difficult and time consuming. Even if successful, litigation to defend our patents against challenges or to enforce our intellectual property rights could be expensive and time consuming and could divert management’s attention from managing our business. Moreover, we may not have sufficient resources to defend our patents against challenges or to enforce our intellectual property rights.

The medical device industry is characterized by patent and other intellectual property litigation and we could become subject to litigation that could be costly, result in the diversion of management’s time and efforts, require us to pay damages, and/or prevent us from marketing our existing or future products.

The medical device industry is characterized by extensive litigation and administrative proceedings over patent and other intellectual property rights. Determining whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that our products, the components of those products, the methods of using those products, or the methods we employ in manufacturing or processing those products are covered by patents held by them. In addition, they may claim that their patents have priority over ours because their patents were filed first. Because patent applications can take many years to issue, there may be applications now pending of which we are unaware, which may later result in issued patents that our products may infringe. There could also be existing patents that one or more components of our

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products may be inadvertently infringing, of which we are unaware. As the number of participants in the market for spine disorder devices and treatments increases, the possibility of patent infringement claims against us also increases.

Any such claim against us, even those without merit, may cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If the relevant patents are upheld as valid and enforceable and we are found to infringe, we could be required to pay substantial damages, including treble, or triple, damages if an infringement is found to be willful, and/or royalties and we could be prevented from selling our products unless we could obtain a license or were able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all, and there can be no assurance that we would be able to redesign our products in a way that would not infringe those patents, and any such redesign, if possible, may be costly. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may have to withdraw existing products from the market or may be unable to commercialize one or more of our products, either of which could have a significant adverse effect on our business, financial condition and results of operations. We may lose market share to our competitors if we fail to protect our intellectual property rights.

In addition, in order to further our product development efforts, from time to time we enter into agreements with surgeons to develop new products. As consideration for product development activities rendered pursuant to these agreements, in certain instances we have agreed to pay such surgeons royalties on products developed by cooperative involvement between us and such surgeons. There can be no assurance that surgeons with whom we have entered into such an arrangement will not claim to be entitled to a royalty even if we do not believe that such products were developed by cooperative involvement between us and such surgeons. Any such claim against us, even those without merit, may cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation.

If we become subject to product liability claims, we may be required to pay damages that exceed our insurance coverage.

Our business exposes us to potential product liability claims that are inherent in the testing, design, manufacture and sale of medical devices for spine surgery procedures. Spine surgery involves significant risk of serious complications, including bleeding, nerve injury, paralysis and even death. To date, our products have not been the subject of any material product liability claims. Currently, we carry product liability insurance in the amount of $20 million per occurrence and $20 million in the aggregate. Our existing product liability insurance coverage may be inadequate to satisfy liabilities we might incur. Any product liability claim brought against us, with or without merit, could result in the increase of our product liability insurance rates or our inability to secure coverage in the future on commercially reasonable terms, if at all. In addition, if our product liability insurance proves to be inadequate to pay a damage award, we may have to pay the excess out of our cash reserves, which could harm our financial condition. If longer-term patient results and experience indicate that our products or any component of our products cause tissue damage, motor impairment or other adverse effects, we could be subject to significant liability. Even a meritless or unsuccessful product liability claim could harm our reputation in the industry, lead to significant legal fees and result in the diversion of management’s attention from managing our business. If a product liability claim or series of claims is brought against us in excess of our insurance coverage limits, our business could suffer and our financial condition, results of operations and cash flow could be materially adversely impacted.

Because biologics products entail a potential risk of communicable disease to human recipients, we may be the subject of product liability claims regarding our biologics products.

Our biologics products may expose us to additional potential product liability claims. The development of biologics products entails a risk of additional product liability claims because of the risk of transmitting disease to human recipients, and substantial product liability claims may be asserted against us. In addition, successful product liability claims made against one of our competitors could cause claims to be made against us or expose us to a perception that we are vulnerable to similar claims. Even a meritless or unsuccessful product liability claim could harm our reputation in the industry, lead to significant legal fees and result in the diversion of management’s attention from managing our business.

Any claims relating to our improper handling, storage or disposal of biological, hazardous and radioactive materials could be time consuming and costly.

The manufacture of certain of our products, including our biologics products, involves the controlled use of biological, hazardous and/or radioactive materials and waste. Our business and facilities and those of our suppliers are subject to foreign, federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials and waste products. Although we believe that our safety procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these materials. In the event of an accident, we could be held liable for damages or penalized with fines. This liability could exceed our resources and any applicable insurance. In addition, under some environmental laws and regulations, we could also be held responsible for all of the costs relating to any contamination at our past or present facilities and at third-party waste disposal sites, even if such contamination

31


was not caused by us. We may incur significant expenses in the future relating to any failure to comply with environmental laws. Any such future expenses or liability could have a significant negative impact on our business, financial condition and results of operations.

We may be subject to damages resulting from claims that we, our employees or our independent distributors have wrongfully used or disclosed alleged trade secrets of our competitors or are in breach of non-competition or non-solicitation agreements with our competitors.

Many of our employees were previously employed at other medical device companies, including our competitors or potential competitors. Many of our independent distributors sell, or in the past have sold, products of our competitors. We may be subject to claims that we, our employees or our independent distributors have inadvertently or otherwise used or disclosed the trade secrets or other proprietary information of our competitors. In addition, we have been and may in the future be subject to claims that we caused an employee or independent distributor to break the terms of his or her non-competition agreement or non-solicitation agreement. Litigation may be necessary to defend against such claims. Even if we are successful in defending against such claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights and/or personnel. A loss of key personnel and/or their work product could hamper or prevent our ability to commercialize products, which could have an adverse effect on our business, financial condition and results of operations.

Risks Related to Our Common Stock

If we fail to continue to meet all applicable NASDAQ Global Select Market requirements and our common stock is delisted, the delisting could adversely affect the market liquidity of our common stock, impair the value of your investment and harm our business.

Our common stock is currently listed on the NASDAQ Global Select Market. In order to maintain that listing, we must satisfy minimum financial and other requirements.  On September 17, 2015, we received written notice from the Listing Qualifications Department of the NASDAQ Stock Market LLC, or NASDAQ, notifying us that for the preceding 30 consecutive business days, our common stock did not maintain a minimum closing bid price of $1.00 per share as required for continued inclusion on The NASDAQ Global Select Market under NASDAQ Listing Rule 5450(a)(1). On August 24, 2016, we effected a 1-for-12 reverse stock split of our common stock in order to regain compliance with the applicable NASDAQ Listing Rules that required us to maintain a minimum closing bid price of $1.00 per share for a minimum of 10 consecutive trading days.

Accordingly, although we are currently in compliance with applicable NASDAQ Global Select Market requirements,  if we fail to continue to meet all such requirements in the future and NASDAQ determines to delist our common stock, the delisting could substantially decrease trading in our common stock and adversely affect the market liquidity of our common stock; adversely affect our ability to obtain financing on acceptable terms, if at all, to continue our operations; and may result in the potential loss of confidence by investors, suppliers, customers and employees and fewer business development opportunities. Additionally, the market price of our common stock may decline further and stockholders may lose some or all of their investment.

We expect that the price of our common stock will fluctuate substantially and the market price of our common stock may decline in value in the future.

The market price of our common stock is likely to be highly volatile and may fluctuate substantially due to many factors, including those described elsewhere in this “Risk Factors” section and the following:

 

volume and timing of orders for our products;

 

quarterly variations in our or our competitors’ results of operations;

 

our announcement or our competitors’ announcements regarding new products, product enhancements, significant contracts, number of distributors, number of hospitals and surgeons using products, acquisitions, and collaborative or strategic investments;

 

announcements of technological or medical innovations for the treatment of spine pathology;

 

changes in earnings estimates or recommendations by securities analysts;

 

our ability to develop, obtain regulatory clearance or approval for, and market new and enhanced products on a timely basis;

 

changes in healthcare policy in the U.S.;

 

product liability claims or other litigation involving us;

32


 

sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;

 

changes in governmental regulations or in the status of our regulatory approvals, clearances or applications;

 

disputes or other developments with respect to intellectual property rights;

 

changes in the availability of third-party reimbursement in the U.S.;

 

changes in accounting principles; and

 

general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.

We may become involved in securities class action litigation that could divert management’s attention and harm our business.

The stock market in general, The NASDAQ Global Select Market and the market for medical device companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of medical device companies have been particularly volatile. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation is often expensive and diverts management’s attention and resources, which could materially harm our financial condition, results of operations and business.

Securities analysts may not continue to provide coverage of our common stock or may issue negative reports, which may have a negative impact on the market price of our common stock.

Securities analysts may not continue to provide research coverage of our common stock. If securities analysts do not cover our common stock, the lack of research coverage may cause the market price of our common stock to decline. The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about our business. If one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline rapidly. If one or more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, it may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.

Because of their significant stock ownership, our executive officers, directors and principal stockholders will be able to exert control over us and our significant corporate decisions.

Based on shares outstanding at March 17, 2017, our executive officers, directors and stockholders holding more than 5% of our outstanding common stock and their affiliates, in the aggregate, beneficially own approximately 35% of our outstanding common stock. As a result, these persons will have the ability to impact significantly the outcome of all matters requiring stockholder approval, including the election and removal of directors and any merger, consolidation, or sale of all or substantially all of our assets.

This concentration of ownership may harm the market price of our common stock by, among other things:

 

delaying, deferring or preventing our change in control;

 

impeding a merger, consolidation, takeover or other business combination involving us;

 

causing us to enter into transactions or agreements that are not in the best interests of all of our stockholders; or

 

reducing our public float held by non-affiliates.

Certain members of our Board of Directors also serve as officers and directors of HealthpointCapital, its affiliates and other portfolio companies.

Three members of our Board of Directors also serve as officers and directors of our largest stockholder, HealthpointCapital, or its related entities and of other companies in which HealthpointCapital invests, including companies with which we compete or may in the future compete. As of March 17, 2017, HealthpointCapital owned approximately 31% of our outstanding common stock. The Chairman of our Board of Directors, Mortimer Berkowitz III, is a managing member of HGP, LLC and HGP II, LLC, the general partners of HealthpointCapital Partners, LP and HealthpointCapital Partners II, LP, respectively. Our directors R. Ian Molson and Stephen E. O’Neil also serve on the board of managers of HealthpointCapital, LLC.  Each of Messrs. Berkowitz, O’Neil and Molson, also have financial interests in HealthpointCapital investment funds.

33


Because of these possible conflicts of interest, such directors may direct potential business and investment opportunities to other entities rather than to us or such directors may undertake or otherwise engage in activities or conduct on behalf of such other entities that is not in, or which may be adverse to, our best interests. Whether a director directs an opportunity to us or to another company, our directors may face claims of breaches of fiduciary duty and other duties relating to such opportunities. Our amended and restated certificate of incorporation requires us to indemnify our directors to the fullest extent permitted by law, which may require us to indemnify them against claims of breaches of such duties arising from their service on our Board of Directors. HealthpointCapital or its affiliates may pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. Furthermore, HealthpointCapital may have an interest in us pursuing acquisitions, divestitures, financings or other transactions that, in its judgment, could enhance its equity investment, even though such transactions might involve risks to us and our stockholders generally. In addition, if we were to seek a business combination with a target business with which one or more of our existing stockholders or directors may be affiliated, conflicts of interest could arise in connection with negotiating the terms of and completing the business combination. Conflicts that may arise may not be resolved in our favor.

Anti-takeover provisions in our organizational documents and change of control provisions in some of our employment agreements and agreements with distributors, and in some of our outstanding debt agreements, as well as the terms of our redeemable preferred stock, may discourage or prevent a change of control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely.

Certain provisions of our amended and restated certificate of incorporation and restated by-laws could discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which our stockholders might otherwise receive a premium for their shares. These provisions also could limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. Stockholders who wish to participate in these transactions may not have the opportunity to do so. Furthermore, these provisions could prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions:

 

allow the authorized number of directors to be changed only by resolution of our Board of Directors;

 

allow vacancies on our Board of Directors to be filled only by resolution of our Board of Directors;

 

authorize our Board of Directors to issue, without stockholder approval, blank check preferred stock that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our Board of Directors;

 

require that stockholder actions must be effected at a duly called stockholder meeting and prohibit stockholder action by written consent;

 

establish advance notice requirements for stockholder nominations to our Board of Directors and for stockholder proposals that can be acted on at stockholder meetings; and

 

limit who may call stockholder meetings.

Some of our employment agreements and all of our restricted stock agreements, incentive stock option agreements, performance-based stock units and restricted common stock provide for accelerated vesting of benefits, including full vesting of restricted stock and options, upon a change of control. A limited number of our agreements with our distributors include a provision that extends the term of the distribution agreement upon a change in control and makes it more difficult for us or our successor to terminate the agreement. These provisions may discourage or prevent a change of control.

In addition, in the event of a change of control, we would be required to redeem all outstanding shares of our redeemable preferred stock for an aggregate of $29.9 million, at the price of $9.00 per share. Further, our amended and restated certificate of incorporation permits us to issue additional shares of preferred stock. The terms of our redeemable preferred stock or any new preferred stock we may issue could have the effect of delaying, deterring or preventing a change in control.

Our stockholders will not receive any distribution of the proceeds from the sale of our international distribution operations and we do not anticipate paying any cash dividends in the foreseeable future, and stockholders may never receive any return of value.

We did not distribute to stockholders any cash proceeds from the Globus Transaction. Instead, we used a portion of the proceeds from the Globus Transaction to repay in full all amounts outstanding and due under our Deerfield Facility Agreement and repay certain of our outstanding indebtedness under our Amended Credit Facility with MidCap, and we intend to use the remainder of the proceeds to fund our future business activities and for general working capital purposes. Any future decision for the use of those funds will be made by our Board of Directors.

34


In addition, we have not declared any cash dividends and do not intend to declare or pay any cash dividends in the foreseeable future. Future earnings, if any, will be used to finance the future operation and growth of our business. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our Board of Directors deems relevant. In addition, our ability to pay dividends is currently restricted by the terms of our Amended Credit Facility with MidCap and Globus Facility Agreement. Stockholders will not receive any liquidity from the Globus Transaction and the only return to them will be based on any future appreciation in our stock price or upon a future sale or liquidation of our company, which may never occur. Much depends on our future business, including the success or failure of our U.S. business. There are no assurances that we will be successful, and current stockholders may never get a return on their investment.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and, in particular, the description of our "Business" set forth in Item 1, the "Risk Factors" set forth in this Item 1A and our "Management’s Discussion and Analysis of Financial Condition and Results of Operations" set forth in Item 7 contain or incorporate a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, including statements regarding:

 

our estimates regarding anticipated operating losses, future revenue, expenses, capital requirements, uses and sources of cash and liquidity, including our anticipated revenue growth and cost savings;

 

our ability to meet the financial covenants under our credit facilities;

 

our ability to ensure that we have effective disclosure controls and procedures;

 

our not realizing the full economic benefit from the Globus Transaction, including as a result of indemnification claims under the definitive agreement and the retention by us of certain liabilities associated with the international business, and our ability to meet our obligations under the Globus supply agreement;

 

our ability to meet and potential liability from not meeting the payment obligations under the Orthotec settlement agreement;

 

our ability to regain and maintain compliance with the quality requirements of the FDA;

 

our ability to market, improve, grow, commercialize and achieve market acceptance of any of our products or any product candidates that we are developing or may develop in the future;

 

our beliefs about the features, strengths and benefits of our products;

 

our ability to continue to enhance our product offerings, outsource our manufacturing operations and expand the commercialization of our products, and the effect of our strategy;

 

our expectations about the timing, costs and benefits of the restructuring and outsourcing of our manufacturing operations;

 

our beliefs about the ability of our supplier relationships and quality processes to fulfill our production requirements;

 

our ability to successfully integrate, and realize benefits from licenses and acquisitions;

 

the effect of any existing or future federal, state or international regulations on our ability to effectively conduct our business;

 

our estimates of market sizes and anticipated uses of our products;

 

our business strategy and our underlying assumptions about market data, demographic trends, reimbursement trends and pricing trends;

 

our ability to achieve profitability, and the potential need to raise additional funding;

 

our ability to maintain an adequate sales network for our products, including to attract and retain independent distributors;

 

our ability to enhance our U.S. distribution network;

 

our ability to increase the use and promotion of our products by training and educating surgeons and our sales network;

 

our ability to attract and retain a qualified management team, as well as other qualified personnel and advisors;

 

our ability to enter into licensing and business combination agreements with third parties and to successfully integrate the acquired technology and/or businesses;

35


 

our management team’s ability to accommodate growth and manage a larger organization;

 

our ability to protect our intellectual property, and to not infringe upon the intellectual property of third parties;

 

the effects of the escalating cost of medical products and services and the effects of market demand, government regulation, third-party reimbursement policies and societal pressures on the healthcare industry and our business;

 

our ability to meet or exceed the industry standard in clinical and legal compliance and corporate governance programs;

 

our beliefs about our competitors and the principal competitive factors in our market and the effect of non-operative treatments on demand for our products;

 

potential liability resulting from litigation;

 

our beliefs about our employee relations;

 

potential liability resulting from a governmental review of our business practices;

 

our beliefs about the usefulness of the non-GAAP financial measures included in this Annual Report on Form 10-K;

 

our beliefs with respect to our critical accounting policies and the reasonableness of our estimates and assumptions; and

 

other factors discussed elsewhere in this Annual Report on Form 10-K or any document incorporated by reference herein or therein.

Any or all of our forward-looking statements in this Annual Report may turn out to be wrong. They can be affected by inaccurate assumptions by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this Annual Report on Form 10-K will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from expected results.

We also provide a cautionary discussion of risks and uncertainties under “Risk Factors” in Item 1A of this Annual Report. These are factors that we think could cause our actual results to differ materially from expected results. Other factors besides those listed there could also adversely affect us.

Without limiting the foregoing, the words “believe,” “anticipate,” “plan,” “expect,” “may,” “could,” “would,” “seek,”  “intend,” and similar expressions are intended to identify forward-looking statements. There are a number of factors and uncertainties that could cause actual events or results to differ materially from those indicated by such forward-looking statements, many of which are beyond our control, including the factors set forth under “Item 1A Risk Factors.” In addition, the forward-looking statements contained herein represent our estimate only as of the date of this filing and should not be relied upon as representing our estimate as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements, except as required by applicable law.

Item 1B.

Unresolved Staff Comments

None.

Item 2.

Properties

Our corporate office is located in Carlsbad, California. The table below provides selected information regarding our current material operating location.

 

Location

 

Use

 

Approximate

Square

Footage

 

 

Lease Expiration

Carlsbad, California

 

Corporate headquarters and product design

 

 

76,693

 

 

July 2021

 

36


Item 3.

Legal Proceedings

We are and may become involved in various legal proceedings arising from our business activities. While management is not aware of any litigation matter that in and of itself would have a material adverse impact on our consolidated results of operations, cash flows or financial position, litigation is inherently unpredictable, and depending on the nature and timing of a proceeding, an unfavorable resolution could materially affect our future consolidated results of operations, cash flows or financial position in a particular period.  We assess contingencies to determine the degree of probability and range of possible loss for potential accrual or disclosure in our consolidated financial statements. An estimated loss contingency is accrued in our consolidated financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly subjective and requires judgments about future events. When evaluating contingencies, we may be unable to provide a meaningful estimate due to a number of factors, including the procedural status of the matter in question, the presence of complex or novel legal theories, and/or the ongoing discovery and development of information important to the matters. In addition, damage amounts claimed in litigation against us may be unsupported, exaggerated or unrelated to reasonably possible outcomes, and as such are not meaningful indicators of our potential liability.

Item 4.

Mine Safety Disclosures

Not applicable.

37


PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is traded on The NASDAQ Global Select Market under the symbol “ATEC.” The following table sets forth the high and low sales prices for our common stock as reported on The NASDAQ Global Select Market for the periods indicated.

On August 24, 2016, we effected a 1-for-12 reverse stock split of our issued and outstanding common stock. The per-share amounts listed in the table below are adjusted for all periods to reflect our 1-for-12 reverse stock split.

 

Year Ended December 31, 2016

 

High

 

 

Low

 

First quarter

 

$

6.96

 

 

$

1.80

 

Second quarter

 

 

4.56

 

 

 

2.16

 

Third quarter

 

 

9.65

 

 

 

2.64

 

Fourth quarter

 

 

9.27

 

 

 

3.12

 

 

Year Ended December 31, 2015

 

High

 

 

Low

 

First quarter

 

$

18.48

 

 

$

15.36

 

Second quarter

 

 

17.76

 

 

 

15.36

 

Third quarter

 

 

17.16

 

 

 

3.84

 

Fourth quarter

 

 

5.40

 

 

 

2.16

 

 

Stockholders

As of March 24, 2017, there were approximately 210 holders of record of an aggregate 9,048,145 outstanding shares of our common stock.

Dividend Policy

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.  In addition, our ability to pay dividends is currently restricted by the terms of the Amended Credit Facility with MidCap and the Globus Facility Agreement.

Issuer Purchases of Equity Securities

Under the terms of our 2016 Equity Incentive Plan and our Amended  and Restated 2005 Employee, Director and Consultant Stock Plan, as amended, which we refer to collectively as the Stock Plans, and prior to the expiration of the Stock Plans in May 2026, we are permitted to award shares of restricted stock to our employees, directors and consultants. These shares of restricted stock are subject to a lapsing right of repurchase by us. We may exercise this right of repurchase in the event that a restricted stock recipient’s employment, directorship or consulting relationship with us terminates prior to the end of the vesting period. If we exercise this right, we are required to repay the purchase price paid by or on behalf of the recipient for the repurchased restricted shares. Repurchased shares are returned to the Stock Plan and are available for future awards under the terms of the Stock Plan. There were no shares of common stock repurchased during the year ended December 31, 2016.

38


Item 6.

Selected Financial Data

The following table sets forth consolidated financial data with respect to the Company for each of the five years in the period ended December 31, 2016. The selected consolidated financial data set forth below have been derived from our audited consolidated financial statements, and may not be indicative of future operating results. The results of operations for the year ended December 31, 2015 include a goodwill and intangible assets impairment charge of $164.3 million. The results of operations for the year ended December 31, 2013 include litigation settlement expenses of $46.0 million.  The selected consolidated financial data set forth below should be read in conjunction with our audited consolidated financial statements and related notes thereto found at “Item 8 Financial Statements and Supplementary Data” and “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.  

The following amounts related to earnings per share and shares outstanding have been adjusted for all periods reported for the 1-for-12 reverse stock split that we effected on August 24, 2016.

As a result of the Globus Transaction, our International Business (as defined in Item 7 below) has been excluded from continuing operations for all periods presented in this report and is reported as discontinued operations. See Note 4 for additional information on the divestiture of the International Business.

 

 

 

 

Year Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

 

(in thousands, except per share amounts)

 

Consolidated Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

120,248

 

 

$

134,388

 

 

$

154,625

 

 

$

148,263

 

 

$

141,355

 

Income (Loss) from continuing operations

 

 

(26,301

)

 

 

(171,253

)

 

 

(98

)

 

 

(63,629

)

 

 

(5,616

)

Loss from discontinued operations

 

 

(3,624

)

 

 

(7,423

)

 

 

(12,784

)

 

 

(18,598

)

 

 

(9,843

)

Net loss

 

$

(29,925

)

 

$

(178,676

)

 

$

(12,882

)

 

$

(82,227

)

 

$

(15,459

)

Net loss per basic share

 

$

(3.49

)

 

$

(21.53

)

 

$

(1.59

)

 

$

(10.25

)

 

$

(2.06

)

Net loss per diluted share

 

$

(3.49

)

 

$

(21.53

)

 

$

(1.90

)

 

$

(10.25

)

 

$

(2.06

)

Weighted-average shares used in computing net loss

   per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares used in calculating basic net loss per share

 

 

8,582

 

 

 

8,298

 

 

 

8,112

 

 

 

8,020

 

 

 

7,518

 

Shares used in calculating diluted net loss per share

 

 

8,582

 

 

 

8,298

 

 

 

8,145

 

 

 

8,020

 

 

 

7,518

 

 

 

 

As of December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

 

(in thousands)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

19,593

 

 

$

6,295

 

 

$

12,595

 

 

$

16,102

 

 

$

16,921

 

Restricted cash

 

 

 

 

 

2,350

 

 

 

4,400

 

 

 

 

 

 

 

Working  capital (deficit)

 

 

32,689

 

 

 

(23,542

)

 

 

49,511

 

 

 

34,026

 

 

 

65,264

 

Total assets

 

 

94,188

 

 

 

146,341

 

 

 

113,112

 

 

 

365,630

 

 

 

382,127

 

Total debt, including current portion

 

 

46,205

 

 

 

80,222

 

 

 

82,673

 

 

 

54,888

 

 

 

41,619

 

Redeemable preferred stock

 

 

23,603

 

 

 

23,603

 

 

 

23,603

 

 

 

23,603

 

 

 

23,603

 

Total stockholders’ (deficit) equity

 

 

(41,504

)

 

 

(36,576

)

 

 

148,954

 

 

 

171,676

 

 

 

245,816

 

 

39


Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and the notes to those statements appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this report include the identification of certain trends and other statements that may predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated. See “Item 1A Risk Factors” included elsewhere in this Annual Report on Form 10-K.

Overview

We are a medical technology company focused on the design, development and promotion of products for the surgical treatment of spine disorders. Our mission is to improve patient lives by delivering advancements in spinal fusion technologies.  We have a comprehensive product portfolio and pipeline that addresses the cervical, thoracolumbar and intervertebral regions of the spine and covers a variety of spinal disorders and surgical procedures. Our principal product offerings are focused on the U.S. market for fusion-based spinal disorder solutions. We believe that our products and systems are attractive to surgeons and patients due to innovative features and benefits that simplify surgical procedures for the surgeon and improve patient outcomes.

Currently, we market and sell our products in the United States through a network of non-exclusive independent distributors and direct sales representatives. We believe there is significant opportunity for us to partner closely with distributors to create a more dedicated and loyal sales channel for the future.  We are eliminating our stocking distributors and are moving our existing distributor relationships to more dedicated and non-competitive partnerships and we intend to add new, high-quality distributors to enable future growth.  

We believe this will allow us to reach an untapped market of surgeons, hospitals and national accounts across the United States, as well as further penetrate existing accounts and territories.

We also employ a national accounts team that is responsible for securing access at hospitals and group purchasing organizations, or GPOs, across the United States. We have had strong success with securing access to hospitals and GPOs.  We believe that this access is a key differentiator for us, and much of our current business is achieved through these accounts.  We will continue to focus our efforts and investment on developing and maintaining relationships with key GPOs and hospital networks in order to secure favorable contracts and develop strategies to convert or grow business within existing accounts.    

We are also striving to drive additional revenue by focusing our capital spend on making strategic investments in commercializing our new products. We are focusing our development and commercialization efforts on differentiated products that we can market through our sales channel.  These innovative products are designed to drive penetration within specific segments within the overall spine market, including the complex spine, deformity, and lateral markets.  We also plan to expand our biologics portfolio through structural allograft, tissue and synthetic bone graft products to support surgeons during the surgical procedure with the goal of achieving high fusion rates.  

Recent Developments

On March 29, 2017, we completed a Private Placement of our  securities to certain institutional and accredited investors, including certain directors and executive officers of the Company, providing for the sale by the Company of 1,809,628 shares of our common stock at a purchase price of $2.00 per share, 15,245 shares of newly designated Series A Convertible Preferred Stock (the “Series A Convertible Preferred Stock”) at a purchase price of $1,000 per share (which Preferred Shares are convertible into approximately 7,622,372 shares of our common stock, subject to limitations on conversion until the approval by our stockholders as required in accordance with the NASDAQ Global Select Market rules), and warrants to purchase up to 9,432,000 shares of our Common Stock at an exercise price of $2.00 per share (the “Warrants”), in a private placement (the “Private Placement”). The Warrants will become exercisable following stockholder approval, are subject to certain ownership limitations, and expire five years after the date of such Stockholder approval. The aggregate gross proceeds for the Private Placement were approximately $18.9 million. We intend to use the net proceeds from the Private Placement for general corporate and working capital purposes.

On September 1, 2016, we completed the sale of our international distribution operations and agreements, including our wholly-owned subsidiaries in Japan, Brazil, Australia, China and Singapore and substantially all of the assets of our other sales operations in the United Kingdom and Italy, or collectively the International Business, to an affiliate of Globus. Following the closing of the Globus Transaction, we now operate in the U.S. market only and are prohibited from marketing and selling our products in foreign markets pursuant to the terms and conditions, and for the time periods, set forth in the definitive documents related to the Globus Transaction.

40


At the closing of the Globus Transaction on September 1, 2016, Globus paid us $80 million in cash, subject to a working capital adjustment. On September 1, 2016, we used approximately $66 million of the consideration received to (i) repay in full all amounts outstanding and due under the Deerfield Facility Agreement, and (ii) repay certain of our outstanding indebtedness under our Amended Credit Facility, in each case, including debt-related costs. Also on September 1, 2016, we entered into the credit, security and guaranty agreement with Globus, or the Globus Facility Agreement, pursuant to which Globus has agreed to loan us up to $30 million, subject to the terms and conditions set forth in the Globus Facility Agreement.

As a result of the sale of our International Business, we have retrospectively revised the consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014, the consolidated statements of cash flows for the years ended December 31, 2016, 2015 and 2014, and the consolidated balance sheets as of December 31, 2016 and 2015, to reflect the financial results from the International Business, and the related assets and liabilities, as discontinued operations.

On August 24, 2016, we filed a certificate of amendment to the Company’s certificate of incorporation with the Secretary of State of the state of Delaware to effectuate a 1-for-12 reverse stock split of our issued and outstanding common stock.  The share and per share amounts in the discussion below gives retrospective effect to the 1-for-12 reverse stock split for all periods presented.

Revenue and Expense Components

The following is a description of the primary components of our revenues and expenses:

Revenues. We derive our revenues primarily from the sale of spinal surgery implants used in the treatment of spine disorders. Spinal implant products include pedicle screws and complementary implants, interbody devices, plates, and tissue-based materials. Our revenues are generated by our direct sales force and independent distributors. Our products are requested directly by surgeons and shipped and billed to hospitals and surgical centers.  Currently, most of our business is conducted with customers within markets in which we have experience and with payment terms that are customary to our business. We may defer revenues until the time of collection if circumstances related to payment terms, regional market risk or customer history indicate that collectability is not reasonably assured.

Cost of revenues. Cost of revenues consists of direct product costs, royalties, milestones, depreciation of our surgical instruments, and the amortization of purchased intangibles. Our product costs consist primarily of direct labor, overhead, and raw materials and components. The product costs of certain of our biologics products include the cost of procuring and processing human tissue. We incur royalties related to the technologies that we license from others and the products that are developed in part by surgeons with whom we collaborate in the product development process. Amortization of purchased intangibles consists of amortization of developed product technology.

Research and development. Research and development expense consists of costs associated with the design, development, testing, and enhancement of our products. Research and development expense also includes salaries and related employee benefits, research-related overhead expenses, fees paid to external service providers in both cash and equity, and costs associated with our Scientific Advisory Board and Executive Surgeon Panels.

In-process research and development, or IPR&D.  IPR&D expense consists of acquired research and development assets that were not part of an acquisition of a business and were not technically feasible on the date we acquired such technology, provided that such technology also did not have any alternative future use at that date.

Sales and marketing. Sales and marketing expense consists primarily of salaries and related employee benefits, sales commissions and support costs, professional service fees, travel, medical education, trade show and marketing costs.

General and administrative. General and administrative expense consists primarily of salaries and related employee benefits, professional service fees, insurance and legal expenses.

Goodwill and intangible assets impairment. The impairment expense relates to impairment charges related to our goodwill balances and intangible assets.

Restructuring expenses. Restructuring expense consists of severance, social plan benefits and related taxes, facility closing costs, manufacturing transfer costs and severance costs incurred following the sale of our International Business and the termination of our manufacturing operations in California.

Total other income (expense). Total other income (expense) includes interest income, interest expense, changes in the fair value of the warrant liabilities, gains and losses from foreign currency exchanges and other non-operating gains and losses.

41


Income tax (benefit) provision. Income tax benefit from continuing operations consists primarily of domestic losses partially offset by state income taxes. ASC 740-20 requires total income tax expense or benefit to be allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income and items charged directly to shareholders’ equity. This allocation is referred to as intra-period tax allocation. The sale of the Company's international distribution operations and several foreign subsidiaries is reported under discontinued operations in the Consolidated Financial Statements. Accordingly, we are required to allocate the provision for income taxes between continuing operations and discontinued operations. For the year ended December 31, 2016, we recognized a gain from discontinued operations before tax, and, as a result, we recorded a tax expense of $6.5 million in discontinued operations and a corresponding tax benefit to continuing operations

Results of Operations

The first table below sets forth our statements of operations data for the periods presented. Our historical results are not necessarily indicative of the operating results that may be expected in the future.

 

 

 

Year Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

 

(in thousands)

 

Revenues

 

$

120,248

 

 

$

134,388

 

 

$

154,625

 

Cost of revenues

 

 

44,114

 

 

 

46,366

 

 

 

44,958

 

Gross profit

 

 

76,134

 

 

 

88,022

 

 

 

109,667

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

9,248

 

 

 

17,615

 

 

 

16,593

 

In-process research and development

 

 

 

 

 

274

 

 

 

527

 

Sales and marketing

 

 

50,962

 

 

 

51,801

 

 

 

55,782

 

General and administrative

 

 

26,339

 

 

 

28,126

 

 

 

34,048

 

Amortization of intangible assets

 

 

934

 

 

 

1,200

 

 

 

1,232

 

Goodwill and intangible assets impairment

 

 

1,736

 

 

 

164,263

 

 

 

 

Restructuring expenses

 

 

2,292

 

 

 

597

 

 

 

 

Total operating expenses

 

 

91,511

 

 

 

263,876

 

 

 

108,182

 

Operating (loss) income

 

 

(15,377

)

 

 

(175,854

)

 

 

1,485

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

3

 

 

 

11

 

 

 

10

 

Interest expense

 

 

(5,368

)

 

 

(4,001

)

 

 

(3,022

)

Loss on debt extinguishment

 

 

(9,478

)

 

 

 

 

 

 

Other income (expense), net

 

 

(715

)

 

 

7,445

 

 

 

1,836

 

Total other income (expense)

 

 

(15,558

)

 

 

3,455

 

 

 

(1,176

)

Pretax income (loss) from continuing operations

 

 

(30,935

)

 

 

(172,399

)

 

 

309

 

Income tax (benefit) provision

 

 

(4,634

)

 

 

(1,146

)

 

 

407

 

Loss from continuing operations

 

 

(26,301

)

 

 

(171,253

)

 

 

(98

)

Loss from discontinued operations, net of taxes

 

 

(3,624

)

 

 

(7,423

)

 

 

(12,784

)

Net loss

 

$

(29,925

)

 

$

(178,676

)

 

$

(12,882

)

 

Year Ended December 31, 2016 Compared to the Year Ended December 31, 2015

Revenues. Revenues were $120.2 million for the year ended December 31, 2016 compared to $134.4 million for the year ended December 31, 2015, representing a decrease of $14.1 million, or 10.5%. The decrease was the result of a decline in the sales amounts to former subsidiaries that are classified in continuing operations ($9.1 million) and a decrease in U.S. revenues ($7.6 million), offset by sales beginning in 2016 to Globus ($2.6 million). The sale of implants and instruments to U.S. hospitals decreased by $1.8 million due to pricing erosion in the mid-single digits, consistent with trends experienced over the past several years, partially offset by an increase in unit volume. The sales to stocking distributors declined from the prior year in the amount of $5.8 million due to the ongoing initiative to eliminate this channel from our U.S. Commercial business.

42


Cost of revenues. Cost of revenues was $44.1 million for the year ended December 31, 2016 compared to $46.4 million for the year ended December 31, 2015, representing a decrease of $2.3 million, or 4.9%. The decrease was the result of an elimination of one-time costs related to 2015 activities ($4.5 million), a reduction in product costs due primarily to lower sales volumes ($1.5 million), a reduction in inventory adjustments ($0.4 million) and a reduction in depreciation and amortization expenses ($0.5 million), offset by an increase in inventory reserves due to excess inventory quantities and product life cycle management activities ($2.9 million), charges related to the discontinuation of a product and the related intangible assets and inventory ($1.6 million) and an increase in royalty expense ($0.2 million). The one-time costs related to 2015 activities include multiple product discontinuations, loss on equipment disposals, and accelerated depreciation related to the restructuring of manufacturing operations, offset by gains recognized in 2016 on the sale of various manufacturing equipment related to the 2015 restructuring of operations.

Gross profit. Gross profit was $76.1 million for the year ended December 31, 2016 compared to $88.0 million for the year ended December 31, 2015, representing a decrease of $11.9 million, or 13.5%. The decrease was a combination of a decline in gross profit on sales to former subsidiaries that are classified in continuing operations ($4.1 million) and the effect of lower U.S. revenues combined with an increase in the cost of revenues ($7.8 million), offset by the reduction in cost of sales due to the elimination of one-time costs related to 2015 activities ($4.5 million).

Gross Margin, Gross Margin was 63.3% for the year ended December 31, 2016 compared to 65.5% for the year ended December 31 2015. The decrease of 2.2 percentage points was the result of an increase in inventory reserves and adjustments (2.5 percentage points), charges related to the discontinuation of a product and the related intangible assets and inventory (1.3 percentage points), a reduction in pricing related to revenues (1.1 percentage points), an increase in royalty expense (0.5 percentage points) and an increase in depreciation expense (0.4 percentage points), offset by the reduction in cost of sales due to the elimination of one-time costs related to 2015 activities (3.4 percentage points) and a reduction in amortization expense (0.2 percentage points).

Gross Margin, excluding intercompany and Globus revenue of $13.3 million and $19.8 million for the year ended December 31, 2016 and 2015, respectively, was 67.0% for the year ended December 31, 2016 compared to 69.4% for the year ended December 31 2015. The decrease of 2.4 percentage points was the result of an increase in inventory reserves (2.8 percentage points), charges related to the discontinuation of a product and the related intangible assets and inventory (1.5 percentage points), an increase in product costs due primarily to negative costs variances related to reduced sourcing volumes (1.3 percentage points),  a reduction in pricing related to revenues (0.9 percentage points), an increase in royalty expense (0.2 percentage points) and an increase in depreciation expense (0.3 percentage points), offset by the reduction in cost of sales due to the elimination of one-time costs related to 2015 activities (4.0 percentage points), a reduction in amortization expense (0.3 percentage points) and a reduction in inventory adjustments (0.3 percentage points).

Research and development. Research and development expense was $9.2 million for the year ended December 31, 2016 compared to $17.6 million for the year ended December 31, 2015 representing a decrease of $8.4 million, or 47.5%. The decrease was related to a reduction of development activities ($3.7 million), a reduction in stock-based compensation related costs under a consulting agreement ($2.9 million) and a reduction in personnel related costs ($1.8 million).

In-process research and development. IPR&D expense was $0.0 million for the year ended December 31, 2016 compared to $0.3 million for the year ended December 31, 2015. The expense in 2015 relates to initial purchase payments in connection with asset purchase agreements for which the underlying product was not technologically feasible at the time the asset was acquired.

Sales and marketing. Sales and marketing expense was $51.0 million for the year ended December 31, 2016 compared to $51.8 million for the year ended December 31, 2015 representing a decrease of $0.8 million, or 1.6%. The decrease was the result of a reduction personnel and related expenses ($2.6 million) and the elimination of the medical device excise tax ($1.2 million), offset by an increase in sales commissions to third party agents ($3.0 million).

General and administrative. General and administrative expense was $26.3 million for the year ended December 31, 2016 compared to $28.1 million for the year ended December 31, 2015, representing a decrease of $1.8 million, or 6.4%. The decrease was primarily due to a reduction in personnel and related expenses ($2.6 million), a reduction in expenses related to information technology ($0.5 million), offset by an increase in consulting and professional fees ($1.3 million).

Amortization of intangible assets. Amortization of intangible assets was $0.9 million for the year ended December 31, 2016 as compared to $1.2 million for the year ended December 31, 2015. This expense represents amortization in the period for intangible assets associated with general business assets which has declined as those assets have either been impaired or become fully amortized.

Goodwill and intangible assets impairment. The goodwill and intangible assets impairment was $1.7 million for the year ended December 31, 2016 compared to $164.3 million for the year ended December 31, 2015.  The 2016 impairment charge relates to intangible assets that we found to be impaired as a result of the Globus Transaction.  The 2015 impairment charge was primarily the result of our goodwill impairment test performed during the third quarter of 2015 triggered by the decline in our share price which resulted in the write off of all of our goodwill.  

43


Restructuring expenses. Restructuring expenses were $2.3 million for the year ended December 31, 2016 compared to $0.6 million for the year ended December 31, 2015. Due to the closing of the Globus Transaction, which eliminated substantially all of our international operations, we began a corporate downsizing initiative to align our cost structure with our current operations. The restructuring costs for the year ended December 31, 2016 consist primarily of severance charges related to headcount reductions ($2.0 million). In July 2015, we announced a restructuring of our manufacturing operations in California in an effort to improve our cost structure. As of December 31, 2016, the manufacturing restructuring was substantially complete and we recorded expenses of approximately $0.3 million in the year ended December 31, 2016 and $0.6 million in the year ended December 31, 2015.

Interest expense. Interest expense was $5.4 million for the year ended December 31, 2016 compared to $4.0 million for the year ended December 31, 2015, representing an increase of $1.4 million, or 34.2%. This increase is primarily related to greater costs in connection with various amendments to our credit facilities with MidCap and the new credit facility with Globus.

Loss on extinguishment of debt.  Loss on extinguishment of debt was $9.5 million for the year ended December 31, 2016. The loss on extinguishment of debt is due to prepayment premium of $5.6 million and the write-off of unamortized debt costs of $3.9 million related to extinguishment of the Deerfield facility.

Other income (expense), net. Other income (expense), net was expense of $0.7 million for the year ended December 31, 2016 compared to income of $7.4 million for the year ended December 31, 2015, representing a decrease in income of $8.2 million. The decrease in income is primarily the result of the decrease in warrant valuation in 2015 of $8.0 million due to the decline in the value of our common stock that occurred in July 2015, compared to an expense of the warrant valuation in 2016 of $0.3 million.

Income tax (benefit) provision. Income tax (benefit) provision for continuing operations was a benefit of ($4.6) million for the year ended December 31, 2016 compared to a benefit of ($1.1) million for the year ended December 31, 2015, representing an increase benefit of $3.5 million.  The 2016 income tax benefit from continuing operations consists of the income tax benefit related to domestic losses partially offset by state income taxes. The 2015 income tax benefit from continuing operations consists primarily of the reversal of deferred tax liabilities associated with tax deductible goodwill, partially offset by state income taxes. We are required allocate the provision for income taxes between continuing operations and other categories of earnings, such as discontinued operations.

Discontinued operations. On July 25, 2016, we entered into the Purchase and Sale Agreement with Globus whereby we agreed to sell all of our International Business to Globus, including our wholly-owned subsidiaries in Japan, Brazil, Australia, China and Singapore and substantially all of the assets of our other sales operations in the United Kingdom and Italy, and on September 1, 2016, we completed the sale to Globus. As a result of our strategic decision to sell the International Business and focus on U.S market, our consolidated statements of operations and the consolidated balance sheets reflect the financial results from the International Business as discontinued operations for all periods presented.

For the year ended December 31, 2016, activity presented under discontinued operations in the consolidated statements of operations represents our commercial operations prior to the sale of the International Business in September 2016 including certain intercompany sales transactions as the Company will have continuing involvement due to future sales to Globus under the Supply Agreement. Certain operating expenses were also allocated to the business activities associated with the discontinued operations as well as interest expense related to our debt that we repaid using the proceeds from the sale of the International Business.

Year Ended December 31, 2015 Compared to the Year Ended December 31, 2014

Revenues. Revenues were $134.4 million for the year ended December 31, 2015 compared to $154.6 million for the year ended December 31, 2014, representing a decrease of $20.2 million, or 13.1%. The decrease was the result of a decrease in U.S. revenues ($22.5 million), offset by an increase in the sales amounts to former subsidiaries ($2.3 million) that are classified in continuing operations. The sale of implants and instruments to U.S. hospitals decreased by $18.9 million due to pricing erosion in the mid-single digits, consistent with trends experienced over the past several years in conjunction with a significant decrease in unit volume. The sales to stocking distributors in the U.S. declined from the prior year in the amount of $3.6 million.

Cost of revenues. Cost of revenues was $46.4 million for the year ended December 31, 2015 compared to $45.0 million for the year ended December 31, 2014, representing an increase of $1.4 million, or 3.0%. The increase was the result of one-time charges for the impairment of certain product-related intangible assets and the disposal of manufacturing equipment ($1.9 million), non-recurring favorable royalties and milestones in 2014 ($1.2 million), an increase in manufacturing depreciation expense due to the reduction of useful lives resulting from the manufacturing outsourcing initiative ($1.5 million), offset by a reduction in product costs due primarily to lower sales volumes ($0.9 million), a reduction in reserves and adjustments ($0.8 million), reduced instrument depreciation expense ($0.6 million), a reduction in royalty and milestone expenses due to a reduction sales volume ($0.5 million), and a reduction in amortization expenses ($0.4 million).

44


Gross profit. Gross profit was $88.0 million for the year ended December 31, 2015 compared to $109.7 million for the year ended December 31, 2014, representing a decrease of $21.6 million, or 19.7%. The decrease was a combination of the effect of lower U.S. revenues combined with an increase in the cost of revenues ($23.0 million), offset by an increase in gross profit on sales to former subsidiaries that are classified in continuing operations ($1.4 million).

Gross margin. Gross margin, excluding intercompany revenue of $10.5 million and $9.1 million for the years ended December 31, 2016 and 2015, respectively, was 67.7% for the year ended December 31, 2015 compared to 73.4 % for the year ended December 31, 2014. The decrease of 5.7 percentage points was due to increased cost of revenues resulting from one-time charges (3.9 percentage points), unfavorable variation in pricing and product mix (1.2 percentage points), increased royalty costs due to a change in product mix (0.6 percentage points) and an increase in instrument depreciation expense (0.5 percentage points), offset by a decrease in inventory reserves and adjustments (0.3 percentage points) and a decrease in amortization expense (0.2 percentage points).

Research and development. Research and development expense was $17.6 million for the year ended December 31, 2015 compared to $16.6 million for the year ended December 31, 2014 representing an increase of $1.0 million, or 6.2%. The increase was primarily due to an increase in stock-based compensation based on a mark-to-market calculation of stock previously provided to outside consultants ($2.9 million), offset by a reduction in personnel costs ($1.5 million) and a reduction related to the timing of development activities and product launch schedules ($0.4 million).

In-process research and development. IPR&D expense was $0.3 million for the year ended December 31, 2015 compared to $0.5 million for the year ended December 31, 2014. The expense in 2015 and 2014 relates to initial purchase payments in connection with asset purchase agreements for which the underlying product was not technologically feasible at the time the asset was acquired.

Sales and marketing. Sales and marketing expense was $51.8 million for the year ended December 31, 2015 compared to $55.8 million for the year ended December 31, 2014 representing a decrease of $4.0 million, or 7.1%. The decrease was due primarily to a reduction in commission expense due to the reduction in revenue ($3.8 million).

General and administrative. General and administrative expense was $28.1 million for the year ended December 31, 2015 compared to $34.0 million for the year ended December 31, 2014, representing a decrease of $5.9 million, or 17.4%. The decrease was due to a reduction in legal expenses associated with the Orthotec litigation ($4.8 million), a reduction in personnel expense ($0.7 million), and a sales tax refund ($0.4 million).

Amortization of intangible assets. Amortization of intangible assets was $1.2 million for both of the years ended December 31, 2015 and 2014. This expense represents amortization in the period for intangible assets associated with general business assets.

Goodwill and intangible assets impairment. The goodwill and intangible assets impairment of $164.3 million for the year ended December 31, 2015 is a result of our impairment test performed during the third quarter of 2015 triggered by the decline in our share price.  The impairment charge represents a full write off of our existing goodwill balance ($164.3 million).

Restructuring expenses. Restructuring expenses were $0.6 million for the year ended December 31, 2015. In July 2015, we announced a restructuring of our manufacturing operations in California in an effort to improve our cost structure. The restructuring includes a reduction in workforce and closing the California manufacturing facility.

Interest expense. Interest expense was $4.0 million for the year ended December 31, 2015 compared to $3.0 million for the year ended December 31, 2014, representing a decrease of $1.0 million. Interest expense for the years ended December 31, 2015 and 2014 consisted primarily of interest related to loan agreements and lines of credit and the associated amortization expenses related to debt issuance costs. The increase was primarily due to higher debt balance during 2015 as compared to 2014.

Other income (expense), net. Other income (expense), net was income of $7.4 million for the year ended December 31, 2015 compared to income of $1.8 million for the year ended December 31, 2014, representing an increase in income of $5.6 million. The increase was due primarily to a decline in the fair value of common stock warrant liability ($5.4 million).

Income tax (benefit) provision. Income tax (benefit) provision was a benefit of $1.1 million for the year ended December 31, 2015 compared to a provision of $0.4 million for the year ended December 31, 2014. The 2015 income tax benefit from continuing operations consists primarily of the reversal of deferred tax liabilities associated with tax deductible goodwill, partially offset by state income taxes.  The 2014 income tax provision from continuing operations consists primarily of income tax provisions related to state income taxes and the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill.

45


Discontinued operations. On July 25, 2016, we entered into the Purchase and Sale Agreement with Globus whereby we agreed to sell all of our International Business to Globus, including our wholly-owned subsidiaries in Japan, Brazil, Australia, China and Singapore and substantially all of the assets of our other sales operations in the United Kingdom and Italy, and on September 1, 2016, we completed the sale to Globus. As a result of our strategic decision to sell the International Business and focus on the U.S market, our consolidated statements of operations and the consolidated balance sheets reflect the financial results from the International Business as discontinued operations for all periods presented.

For the years ended December 31, 2016, 2015 and 2014, activity presented under discontinued operations in the  consolidated statements of operations represents our commercial operations the prior to the sale of the International Business in September 2016 including certain intercompany sales transactions as the Company will have continuing involvement due to future sales to Globus under the Supply Agreement. Certain operating expenses were also allocated to the business activities associated with the discontinued operations as well as interest expense related to our debt that we repaid using the proceeds from the sale of the International Business.

Non-GAAP Financial Measures

We utilize certain financial measures that are not calculated based on U.S. Generally Accepted Accounting Principles, or GAAP. Certain of these financial measures are considered “non-GAAP” financial measures within the meaning of Item 10 of Regulation S-K promulgated by the SEC. We believe that non-GAAP financial measures reflect an additional way of viewing aspects of our operations that, when viewed with the GAAP results, provide a more complete understanding of our results of operations and the factors and trends affecting our business. These unaudited non-GAAP financial measures are also used by our management to evaluate financial results and to plan and forecast future periods. However, non-GAAP financial measures should be considered as a supplement to, and not as a substitute for, or superior to, the corresponding measures calculated in accordance with GAAP. Non-GAAP financial measures used by us may differ from the non-GAAP measures used by other companies, including our competitors.

Adjusted EBITDA represents net income (loss) excluding the effects of interest, taxes, depreciation, amortization, stock-based compensation and other non-recurring income or expense items, such as in-process research and development expense and acquisition related transaction expenses, restructuring expenses, litigation exposure expenses, trial related legal costs and litigation settlement expenses. We believe that the most directly comparable GAAP financial measure to adjusted EBITDA is net income (loss). Adjusted EBITDA has limitations, however, and therefore, should not be considered either in isolation or as a substitute for analysis of our results as reported under GAAP. Furthermore, adjusted EBITDA should not be considered as an alternative to operating income (loss) or net income (loss) as a measure of operating performance or to net cash provided by operating, investing or financing activities, or as a measure of our ability to meet cash needs.

The following is a reconciliation of adjusted EBITDA to the most comparable GAAP measure, net loss, for the years ended December 31, 2016, 2015 and 2014 (in thousands):

 

 

 

Year Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

Net loss

 

$

(29,925

)

 

$

(178,676

)

 

$

(12,882

)

Stock-based compensation

 

 

1,626

 

 

 

2,567

 

 

 

4,404

 

Depreciation

 

 

7,387

 

 

 

10,802

 

 

 

9,542

 

Amortization of intangible assets

 

 

1,608

 

 

 

2,968

 

 

 

2,248

 

Goodwill and intangible assets impairment

 

 

1,736

 

 

 

164,263

 

 

 

 

In-process research and development

 

 

 

 

 

274

 

 

 

527

 

Stock price guarantee

 

 

1,815

 

 

 

4,878

 

 

 

 

Interest expense, net

 

 

5,365

 

 

 

3,990

 

 

 

3,012

 

Loss on debt extinguishment

 

 

9,478

 

 

 

 

 

 

 

Income tax (benefit) provision

 

 

(4,634

)

 

 

(1,146

)

 

 

407

 

Other (income) expense, net

 

 

715

 

 

 

(7,445

)

 

 

(1,836

)

Restructuring and other expenses

 

 

2,292

 

 

 

597

 

 

 

36

 

Net loss from discontinued operations

 

 

3,624

 

 

 

7,423

 

 

 

12,784

 

Litigation expenses and trial costs

 

 

 

 

 

 

 

 

4,779

 

Adjusted EBITDA

 

$

1,087

 

 

$

10,495

 

 

$

23,021

 

 

46


Liquidity and Capital Resources

We have incurred significant net losses since inception and relied on our ability to fund our operations through revenues from the sale of our products, equity financings and debt financings. As we have incurred losses, a successful transition to profitability is dependent upon achieving a level of revenues adequate to support our cost structure. This may not occur and, unless and until it does, we will continue to need to raise additional capital. At December 31, 2016, our principal sources of liquidity consisted of cash of $19.6 million and accounts receivable, net of $18.5 million.  Together with the proceeds of our $18.9 million private placement in March 2017, we currently estimate this will provide sufficient capital to fund our operations through at least the next 12 months.

Historically, our principal sources of cash have included customer payments from the sale of our products, proceeds from the issuance of common and preferred stock and proceeds from the issuance of debt. Our principal uses of cash have included cash used in operations, payments relating to purchases of surgical instruments, repayments of borrowings under the Amended Credit Facility, payments due under the Orthotec settlement agreement and acquisitions of businesses and intellectual property rights. We expect that our principal uses of cash in the future will be these same uses of cash. We expect that, as our revenues grow, our sales and marketing, research and development expenses and our capital expenditures will continue to grow and, as a result, we will need to generate significant net revenues to achieve profitability.  Operating losses and negative cash flows may continue for at least the next year as we continue to incur costs related to the execution of our operating plan and introduction of new products.

We may seek additional funds from public and private equity or debt financings, borrowings under new or existing debt facilities or other sources to fund our projected operating requirements.  However, there is no guarantee that we will be able to obtain further financing, or do so on reasonable terms. If we are unable to raise additional funds on a timely basis, or at all, we would be materially adversely affected.

On July 6, 2015, we announced a restructuring of our manufacturing operations in California in an effort to improve our cost structure.  The restructuring included a reduction in workforce and closing our California manufacturing facility. This restructuring was substantially completed in 2016.

On July 25, 2016, we entered into the Purchase and Sale Agreement, with Globus, pursuant to which, and on the terms and subject to the conditions thereof, among other things, Globus agreed to acquire our International Business.  Upon the closing, of the Globus Transaction on September 1, 2016, or the Closing, Globus paid us $80 million in cash, subject to a working capital adjustment, or the Closing Payment. Following the Closing, we have used approximately $66 million of the Closing Payment to (i) repay in full all amounts outstanding and due under our credit facility with Deerfield and (ii) repay certain of our outstanding indebtedness under our Amended Credit Facility with MidCap, in each case, including debt-related costs. At the Closing, we also entered into the Globus Facility Agreement pursuant to which Globus agreed to loan us up to $30 million, of which $25 million was drawn at the Closing and an additional $5 million draw in the fourth quarter of 2016, subject to the terms and conditions set forth in the Globus Facility Agreement.

Following the Globus Transaction, the Company reduced its U.S. workforce by approximately 20%.  Our chief executive officer, chief financial officer and SVP, Global Human Resources also departed the Company at that time.  As a result of this workforce reduction and such departures, the Company incurred restructuring charges, of approximately $1.9 million, in connection with one-time employee termination costs, including severance and other benefits.

A substantial portion of our available cash funds is held in business accounts with reputable financial institutions. At times, however, our deposits, may exceed federally insured limits and thus we may face losses in the event of insolvency of any of the financial institutions where our funds are deposited. We did not hold any marketable securities as of December 31, 2016.

Amended Credit Facility and Other Debt

On August 30, 2013, we entered into the Amended Credit Facility, which amended and restated the prior credit facility that we had with MidCap. On September 1, 2016, we entered into a Fifth Amendment to the MidCap Amended Facility Agreement, or the MidCap Fifth Amendment, that: (a) permitted (i) the Globus Transaction, (ii) the release of Alphatec International LLC and Alphatec Pacific, Inc. as credit parties, (iii) the payment in full of all obligations to Deerfield  under the Facility Agreement between us and Deerfield, dated as of March 17, 2014, as amended to date, or the Deerfield Facility Agreement, and (iv) the incurrence of debt under the Globus Facility Agreement and the granting of liens in favor of Globus, (b) reduced the revolving credit commitment to $22.5 million and the term loan commitment to $5 million, (c) revised the existing financial covenant package, and (d) extended the commitment expiry date from December 31, 2016 to December 31, 2019. In connection with the prepayment of the term loan under the Amended Credit Facility, we incurred a prepayment fee of $0.6 million payable to MidCap.

47


The term loan interest rate is priced at the London Interbank Offered Rate, or LIBOR, plus 8.0%, subject to a 9.5% floor, and the revolving line of credit interest rate remains priced at LIBOR plus 6.0%, reset monthly. At December 31, 2016, the revolving line of credit carried an interest rate of 6.6% and the term loan carries an interest rate of 9.5%. The borrowing base is determined, from time to time, based on the value of domestic eligible accounts receivable and domestic eligible inventory. As collateral for the Amended Credit Facility, we granted MidCap a security interest in substantially all of its assets, including all accounts receivable and all securities evidencing its interests in our subsidiaries. In addition to monthly payments of interest, monthly repayments of $0.2 million in 2017 and $0.3 million in 2018 through maturity are due, with the remaining principal due upon maturity.

The Amended Credit Facility includes traditional lending and reporting covenants including a liquidity calculation and a fixed charge coverage ratio to be maintained by us. The Amended Credit Facility also includes several event of default provisions, such as payment default, insolvency conditions and a material adverse effect clause, which could cause interest to be charged at a rate which is up to five percentage points above the rate effective immediately before the event of default or result in MidCap’s right to declare all outstanding obligations immediately due and payable.  

On March 11, 2016, we entered into a Third Amendment and Waiver to the Amended Credit Facility with MidCap, or the Third Amendment to the Amended Credit Facility. The Third Amendment to the Amended Credit Facility extended the maturity date of the Amended Credit Facility from August 30, 2016 to December 31, 2016 and contains an amendment fee in the amount of $0.5 million, which is due and payable at the earlier of the termination of the Amended Credit Facility or the maturity date. The Third Amendment to the Amended Credit Facility also contains a waiver of the December 2015 defaults under the Facility Agreement, provides a waiver for the fixed charge coverage ratio for January 2016 and eliminates the fixed charge coverage ratio covenant for February 2016.  At December 31, 2016, $1.9 million remains as unamortized debt discount related to the Amended Credit Facility and the prior credit facility with MidCap within the unaudited consolidated balance sheet, which will be amortized over the remaining term of the Amended Credit Facility.

On August 8, 2016, we entered into a Fourth Amendment to the Amended Credit Facility with MidCap, or the Fourth Amendment to the Amended Credit Facility. The Fourth Amendment to the Amended Credit Facility provided for a $2.2 million increase to the borrowing base until September 15, 2016, and includes an amendment fee of $0.2 million, which was due and paid on August 8, 2016. The Fourth Amendment to the Amended Credit Facility also contains a waiver for the May and June 2016 non-compliances.

On March 17, 2014, we entered into the Deerfield Facility Agreement, pursuant to which Deerfield agreed to loan us up to $50 million, subject to the terms and conditions set forth in the Deerfield Facility Agreement. Under the terms of the Deerfield Facility Agreement, we had the option, but were not required, upon certain conditions to draw the entire amount available under the Deerfield Facility Agreement, at any time until January 30, 2015, provided that the initial draw be used for a portion of the payments made in connection with the Orthotec settlement described above, or the Litigation Satisfaction. Following such initial draw down, we had the opportunity to draw down additional amounts under the Deerfield Facility Agreement up to an aggregate of $15.0 million for working capital or general corporate purposes. We agreed to pay Deerfield, upon each disbursement of funds under the Deerfield Facility Agreement, a transaction fee equal to 2.5% of the principal amount of the funds disbursed in addition to the issuance of additional warrants to purchase up to 833,333 shares of our common stock to Deerfield.  In connection with the execution of the Deerfield Facility Agreement, we issued to Deerfield warrants to purchase an aggregate of 520,833 shares of our common stock, or the Initial Warrants. Additionally, we agreed that upon each disbursement under the Deerfield Facility Agreement we would issue to Deerfield warrants to purchase up to 833,333 shares of our common stock, in proportion to the amount of draw compared to the total $50 million facility, or the Draw Warrants.

In March 2014, we drew $26 million under the Deerfield Facility Agreement and received net proceeds of $25.4 million to fund a portion of the Orthotec settlement payment obligations. In November 2014, we drew an additional $6 million under the Deerfield Facility Agreement and received net proceeds of $5.9 million to fund additional Orthotec settlement payment obligations. The $0.7 million in transaction fees were recorded as a debt discount and were being amortized over the term of the draw. In connection with this borrowing, we issued Draw Warrants to purchase 433,333 shares of common stock, which were valued at $5.6 million and recorded as a debt discount and were being amortized over the term of the draw.

On February 5, 2016, we entered into a Limited Waiver and Second Amendment to the Deerfield Facility Agreement, or the Deerfield Facility Agreement Second Amendment. The Deerfield Facility Agreement Second Amendment increased the interest rate under the Deerfield Facility Agreement from 8.75% per annum to 14.75% per annum. In addition, under the Deerfield Facility Agreement Second Amendment we had an option to elect to have (i) until August 30, 2016, six percent (6%), and (ii) thereafter, three percent (3%), in each case, of the interest on the outstanding principal amount under the Deerfield Facility Agreement paid in kind, which would be added to the outstanding principal amount under the Deerfield Facility Agreement and bear interest at the interest rate of 14.75% per annum, hereinafter referred to as the PIK Interest. All accrued and unpaid PIK Interest was due and payable when the outstanding amounts under the Deerfield Facility Agreement were due and payable thereunder or were fully repaid, whichever would occur first. The Deerfield Facility Agreement Second Amendment also contained an amendment fee in the amount of $0.6 million,

48


which was due and payable in installments of $0.2 million in March 2017, March 2018 and March 2019 on the third, fourth and fifth anniversaries of the Deerfield Facility Agreement; provided, that all unpaid amendment fees shall be due and payable when the outstanding amounts under the Deerfield Facility Agreement were due and payable or were fully repaid, whichever occurs first. The Deerfield Facility Agreement Second Amendment also changed the prior date of March 31, 2017 to March 31, 2018, as the date through which we were obligated to pay interest in the event we prepay amounts outstanding under the Deerfield Facility Agreement prior to such date. The Deerfield Facility Agreement Second Amendment also contained the waivers of the defaults under the Deerfield Facility Agreement for the fixed charge coverage ratio through March 2016, but not for the default under the senior leverage ratio or total leverage ratio financial covenants.

As of December 31, 2016, Orthotec settlement payments of $27.4 million have been made. Additionally, an Orthotec settlement payment of $1.1 million was made on January 1, 2017. As of December 31, 2016, there remains aggregate of $30.4 million of Orthotec settlement payments to be paid by us.

In September 2016, in connection with the Globus Transaction, Deerfield exercised its right to convert all outstanding Initial Warrants and Draw Warrants into shares of our common stock based on the Black-Scholes value of the warrants. The outstanding warrants were converted into 268,614 shares of our common stock. Prior to the conversion, the outstanding warrants were periodically revalued to their fair value, included in other income/expense. The change in the fair value of the warrants resulted in an expense of $0.4 million and a gain of  $8.0 million for the years ended December 31, 2016 and 2015, respectively, which is included in other non-cash items in the  consolidated statements of cash flows.

On September 1, 2016, in connection with the Globus Transaction, we repaid in full all amounts outstanding and due under the Deerfield Facility Agreement and terminated the Deerfield Facility Agreement. Pursuant to the Globus Facility Agreement and the MidCap Fifth Amendment, we made a final payment of $33.5 million to Deerfield, consisting of outstanding principal and accrued interest of $27.9 million, a prepayment premium of $5.6 million and other related fees and expenses and wrote-off $3.9 million of unamortized expenses resulting in a loss on debt extinguishment of $9.5 million, which is included other income (expense) for the years ended December 31, 2016 and 2015. The interest expense historically incurred in connection with the Deerfield Facility of $4.0 million and $4.7 million for the years ended December 31, 2016 and 2015, respectively, is included in the loss from discontinued operations to the extent these debt facilities were repaid using the proceeds from the Globus transaction.

On September 1, 2016, we entered into the Globus Facility Agreement, pursuant to which Globus agreed to loan us up to $30 million, subject to the terms and conditions set forth in the Globus Facility Agreement. We made an initial draw of $25 million under the Globus Facility Agreement and a subsequent draw of $5 million. The remaining amount may be advanced in up to two additional draws, each in an aggregate amount of no less than $2 million, as requested by us at any time prior to December 31, 2017. As of December 31, 2016, the outstanding balance under the Globus Facility Agreement was $30.0 million, which becomes due and payable in quarterly payments of $0.8 million starting November 2018 and the final payment due on September 30, 2021. The term loan interest rate is priced at LIBOR plus 8.0% through September 1, 2018, and LIBOR plus 13.0%, thereafter.

As collateral for the Globus Facility Agreement, we granted Globus a first lien security interest in substantially all of our assets, other than accounts receivable and related assets, which will secure the Globus Facility Agreement on a second lien basis.  The Globus Facility Agreement includes traditional lending and reporting covenants including a liquidity calculation and a fixed charge coverage ratio to be maintained by us that are consistent with the covenants under the Amended Credit Facility. The financial covenants of the Globus Facility Agreement are not effective until April 2017. There is no assurance that we will be in compliance with the financial covenants of the Globus Facility Agreement in the future. The Globus Facility Agreement also includes several event of default provisions, such as payment default, insolvency conditions and a material adverse effect clause, which could cause interest to be charged at a rate which is up to five percentage points above the rate effective immediately before the event of default or result in Globus’s right to declare all outstanding obligations immediately due and payable.

We have various capital lease arrangements. The leases bear interest at rates ranging from 6.6% to 9.6%, are generally due in monthly principal and interest installments, are collateralized by the related equipment, and have various maturity dates through September 2018. As of December 31, 2016, the balance of these capital leases, net of interest totaled $0.7 million.

49


Operating Activities

We used net cash of $10.0 million from operating activities for the year ended December 31, 2016. During this period, net cash used by operating activities primarily consisted of a net loss of $29.9 million and working capital and other assets used cash of $2.5 million, which were offset by $22.5 million of non-cash costs including amortization, depreciation, gain on sale of business, loss on extinguishment of debt, deferred income taxes, stock-based compensation, provision for doubtful accounts, provision for excess and obsolete inventory, and interest expense related to amortization of debt discount and issuance costs. Working capital and other assets used cash of $2.6 million primarily consisted of an increase in inventories of $5.7 million and a decrease in accounts payable of $4.9 million and accrued expenses and other of $3.5 million, partially offset by a decrease accounts receivable of $8.0 million, restricted cash of $2.4 million, prepaid expenses and other current assets of $1.3 million. The decrease in accounts receivable is primarily due to the sale of the International Business to Globus. The decrease in accounts payable is primarily due to use of the cash proceeds from the Globus Transaction to pay down payables.

Investing Activities

We provided cash of $62.0 million in investing activities for the year ended December 31, 2016, primarily due to the $69.8 million of net proceeds we received from the sale of our International Business and cash from the sale of assets of $1.3 million.  We used $8.9 million of cash primarily for the purchase of surgical instruments.

Financing Activities

Financing activities used net cash of $43.4 million for the year ended December 31, 2016. Under the Amended Credit Facility with MidCap, we made net principal payments totaling $16.3 million during the year ended December 31, 2016. We made principal payments on notes payable and capital leases totaling $54.4 million in the year ended December 31, 2016 for the payoff of the Deerfield Facility and substantially all of the term debt with Midcap.  We received proceeds from notes payable of $30 million from the Globus Facility Agreement.

Contractual obligations and commercial commitments

Total contractual obligations and commercial commitments as of December 31, 2016 are summarized in the following table (in thousands):

 

 

 

Payment Due by Year

 

 

 

Total

 

 

2017

 

 

2018

 

 

2019

 

 

2020

 

 

2021

 

 

Thereafter

 

Amended Credit Facility with MidCap

 

$

17,873

 

 

$

2,400