Alphatec Spine, Inc.
Alphatec Holdings, Inc. (Form: 10-Q, Received: 08/14/2006 06:08:38)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2006

 

OR

 

o                        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.)

 

2051 Palomar Airport Road, Suite 100
Carlsbad, CA 92011

(Address of principal executive offices, including zip code)

 

(760) 431-9286

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 o  No x

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

Non-accelerated filer x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes o  No x

 

As of July 28, 2006, there were 34,799,022 shares of the registrant’s common stock outstanding.

 

 



 

ALPHATEC HOLDINGS, INC.

QUARTERLY REPORT ON FORM 10-Q

June 30, 2006

 

TABLE OF CONTENTS

 

PART I—FINANCIAL INFORMATION

 

Item 1.

Financial Statements (unaudited)

3

 

Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005

3

 

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005

4

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005

6

 

Notes to Financial Statements

8

Item 2.

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

24

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

Item 4.

Controls and Procedures

36

PART II—OTHER INFORMATION

 

Item 1.

Legal Proceedings

38

Item 1A.

Risk Factors

38

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

59

Item 5

Other Information

59

Item 6.

Exhibits

59

EXHIBITS

 

60

SIGNATURES

61

 

2



 

PART I.  FINANCIAL INFORMATION

 

Item 1.                          Financial Statements

 

ALPHATEC HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

25,020

 

$

2,180

 

Accounts receivable, net

 

13,537

 

9,361

 

Inventories, net

 

10,625

 

8,458

 

Prepaid expenses and other current assets

 

2,279

 

1,050

 

Deferred income tax assets

 

3,057

 

3,057

 

Total current assets

 

54,518

 

24,106

 

Property and equipment, net

 

11,469

 

7,206

 

Goodwill

 

60,897

 

60,946

 

Intangibles, net

 

11,974

 

13,644

 

Other assets

 

621

 

3,237

 

Total assets

 

$

139,479

 

$

109,139

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity (Deficit)

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

4,103

 

$

4,103

 

Accrued expenses

 

9,740

 

8,832

 

Lines of credit

 

1,719

 

3,942

 

Current portion of long-term debt

 

2,471

 

1,280

 

Current portion of note payable to related party

 

 

1,700

 

Total current liabilities

 

18,033

 

19,857

 

 Long-term debt, less current portion

 

3,333

 

1,728

 

 Note payable to related party, less current portion

 

 

781

 

 Other long-term liabilities

 

1,581

 

1,711

 

 Deferred income tax liabilities

 

3,057

 

3,057

 

 Commitments and contingencies

 

 

 

 

 

 Minority interest

 

3,377

 

1,914

 

Redeemable convertible preferred, Rolling common and Series C common stock, $0.0001 par value; 10,929,094 shares authorized at December 31, 2005; no shares and 8,773,447 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively

 

 

99,413

 

New Redeemable preferred stock, $0.0001 par value; 20,000,000 authorized at June 30, 2006; 3,333,201 and no shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively

 

23,703

 

 

Stockholder notes receivable

 

(10

)

(65

)

Stockholders’ equity (deficit):

 

 

 

 

 

 Common stock, $.0001 par value; 200,000,000 shares authorized, 34,799,022 and 20,601,578 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively

 

3

 

1

 

Additional paid-in capital

 

115,288

 

12,016

 

Deferred compensation

 

 

(18,296

)

Accumulated other comprehensive income (loss)

 

53

 

(112

)

Accumulated deficit

 

(28,939

)

(12,866

)

Total stockholders’ equity (deficit)

 

86,405

 

(19,257

)

Total liabilities and stockholders’ equity (deficit)

 

$

139,479

 

$

109,139

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3



 

ALPHATEC HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and in thousands, except per share amounts)

 

 

 

Three Months Ended

 

 

 

June 30,

 

 

 

2006

 

2005

 

Revenues

 

$

19,422

 

$

8,320

 

Cost of revenues

 

6,567

 

3,805

 

Gross profit

 

12,855

 

4,515

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Research and development

 

856

 

177

 

In-process research and development

 

 

 

Sales and marketing

 

7,998

 

3,297

 

General and administrative

 

7,811

 

2,856

 

Total operating expenses

 

16,665

 

6,330

 

Operating loss

 

(3,810

)

(1,815

)

Interest and other income (expense), net

 

(706

)

(69

)

Loss before tax

 

(4,516

)

(1,884

)

Income tax (benefit) provision

 

(1,338

)

(607

)

Net loss

 

(3,178

)

(1,277

)

Accretion to redemption value of redeemable convertible preferred stock, Rolling common and Series C common stock

 

(1,508

)

(1,709

)

Net loss applicable to common stockholders

 

$

(4,686

)

$

(2,986

)

 

 

 

 

 

 

Net loss per share applicable to common stockholders - basic and diluted

 

$

(0.20

)

$

(0.17

)

 

 

 

 

 

 

Weighted average shares - basic and diluted

 

23,045

 

17,809

 

 

See accompanying notes to unaudited condensed consolidated financial statements .

 

4



 

ALPHATEC HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, continued

(Unaudited and in thousands, except per share amounts)

 

 

 

Six Months Ended

 

Successor

 

Predecessor

 

 

 

June 30,

 

March 18,

 

January 1, 2005

 

 

 

 

 

Combined

 

2005 to June

 

to March 17,

 

 

 

2006

 

2005

 

30, 2005

 

2005

 

Revenues

 

$

37,451

 

$

15,221

 

$

9,171

 

$

6,050

 

Cost of revenues

 

12,977

 

5,806

 

4,124

 

1,682

 

Gross profit

 

24,474

 

9,415

 

5,047

 

4,368

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

1,560

 

470

 

254

 

216

 

In-process research and development

 

 

3,100

 

3,100

 

 

Sales and marketing

 

14,543

 

6,728

 

6,728

 

 

General and administrative

 

15,292

 

5,355

 

127

 

5,228

 

Total operating expenses

 

31,395

 

15,653

 

10,209

 

5,444

 

Operating loss

 

(6,921

)

(6,238

)

(5,162

)

(1,076

)

Interest and other income (expense), net

 

(2,197

)

(180

)

(69

)

(111

)

Loss before tax

 

(9,118

)

(6,418

)

(5,231

)

(1,187

)

Income tax (benefit) provision

 

(64

)

(457

)

(459

)

2

 

Net loss

 

(9,054

)

(5,961

)

(4,772

)

(1,189

)

Accretion to redemption value of redeemable convertible preferred stock, Rolling common and Series C common stock

 

(3,450

)

(1,940

)

(1,940

)

 

Net loss applicable to common stockholders

 

$

(12,504

)

$

(7,901

)

$

(6,712

)

$

(1,189

)

 

 

 

 

 

 

 

 

 

 

Net loss per share applicable to common stockholders - basic and diluted

 

$

(0.60

)

$

(0.45

)

$

(0.38

)

$

(0.13

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares - basic and diluted

 

20,856

 

17,500

 

17,500

 

9,211

 

 


Notes:

(1)  See Note 1 of the Notes to Unaudited Condensed Consolidated Financial Statements for a description of the Sucessor and Predecessor.

 

See accompanying notes to unaudited condensed consolidated financial statements .

 

5



 

ALPHATEC HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands)

 

 

 

 

 

 

 

 

 

Predecessor

 

 

 

Six Months Ended

 

Successor

 

January 1,

 

 

 

June 30,

 

March 18,

 

2005 to

 

 

 

 

 

Combined

 

2005 to June

 

March 17,

 

 

 

2006

 

2005

 

30, 2005

 

2005

 

Operating activities:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(9,054

)

$

(5,961

)

$

(4,772

)

$

(1,189

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

3,155

 

362

 

203

 

159

 

Stock-based compensation

 

3,525

 

2,160

 

 

2,160

 

Write-off of purchased in-process research and development

 

 

3,100

 

3,100

 

 

Interest expense related to amortization of debt discount and revaluation of put right

 

1,925

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accounts receivable

 

(4,151

)

(1,723

)

(322

)

(1,401

)

Inventories

 

(2,131

)

(1,097

)

(1,013

)

(84

)

Prepaid expenses and other current assets

 

(1,225

)

(1,238

)

(997

)

(241

)

Income taxes receivable

 

(1

)

(62

)

(62

)

 

Other assets

 

2,622

 

(322

)

(328

)

6

 

Accounts payable

 

(22

)

184

 

98

 

86

 

Accrued expenses and other

 

693

 

963

 

665

 

298

 

Net cash used in operating activities

 

(4,664

)

(3,634

)

(3,428

)

(206

)

 

 

 

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

Acquisition of Alphatec Manufacturing, Inc., net of cash acquired

 

(5

)

(69,294

)

(69,294

)

 

Acquisition of certain assest and liabilities of Cortek, Inc., net of cash acquired

 

54

 

 

 

 

Purchases of property and equipment

 

(5,711

)

(355

)

(295

)

(60

)

Net cash used in investing activities

 

(5,662

)

(69,649

)

(69,589

)

(60

)

 

 

 

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

 

 

 

Net proceeds from issuance of common stock

 

70,237

 

 

 

 

Proceeds from issuance of Rolling common, Series C common and preferred stock

 

223

 

87,361

 

87,361

 

 

Net borrowings under lines of credit

 

(2,243

)

 

 

 

Principal payments on capital lease obligations

 

(407

)

(193

)

(38

)

(155

)

Proceeds from issuance of notes payable

 

3,413

 

 

 

 

Principal payments on notes payable

 

(3,159

)

(2,818

)

(2,738

)

(80

)

Stock redemption

 

(35,154

)

 

 

 

Repayment of stockholder notes receivable

 

65

 

2

 

 

2

 

Net cash provided by (used in) financing activities

 

32,975

 

84,352

 

84,585

 

(233

)

Effect of exchange rate changes on cash and cash equivalents

 

191

 

(10

)

(8

)

(2

)

Net increase (decrease) in cash and cash equivalents

 

22,840

 

11,059

 

11,560

 

(501

)

Cash and cash equivalents at beginning of period

 

2,180

 

1,557

 

 

1,557

 

Cash and cash equivalents at end of period

 

$

25,020

 

$

12,616

 

$

11,560

 

$

1,056

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6



 

ALPHATEC HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued

(Unaudited and in thousands)

 

 

 

 

 

 

 

Successor

 

Predecessor

 

 

 

Six Months Ended

 

March 18,

 

January 1,

 

 

 

June 30,

 

2005 to

 

2005 to

 

 

 

 

 

Combined

 

June 30,

 

March 17,

 

 

 

2006

 

2005

 

2005

 

2005

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

396

 

$

431

 

$

329

 

$

102

 

Accretion to redemption value of redeemable stock

 

$

3,450

 

$

1,940

 

$

1,940

 

$

 

 

 

 

 

 

 

 

 

 

 

Purchases of property and equipment through capital leases

 

$

46

 

$

94

 

$

94

 

$

 

Forgiveness of notes receivable from stockholders

 

$

 

$

195

 

$

204

 

$

(9

)

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

7



 

Alphatec Holdings , Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

1. The Company

 

Alphatec Holdings, Inc. (“Alphatec,” “Alphatec Holdings,” the “Successor,” the “Company,” “we,” “our” or “us”) was incorporated in the state of Delaware in March 2005 in order to acquire 100% of the outstanding capital stock of Alphatec Spine, Inc. (the “Predecessor” or “Alphatec Spine”) on March 18, 2005. Alphatec Spine, formerly known as Alphatec Manufacturing, Inc., is a California corporation that was incorporated in May 1990 and is engaged in the development, manufacturing, and sale of medical devices for use in orthopedic spinal surgeries.

 

2. Basis of Presentation

 

The consolidated financial statements of the Predecessor include the accounts of Alphatec Spine and its wholly owned subsidiaries, Nexmed, Inc. (“Nexmed”), a California corporation, Milverton Limited (“Milverton”), a Hong Kong corporation, and Alphatec Pacific, Inc. (“Alphatec Pacific”), a Japanese corporation.

 

The consolidated financial statements of the Successor include the accounts of Alphatec Holdings, Alphatec Spine, Alphatec Spine’s wholly owned subsidiaries, Nexmed and Milverton, and Alphatec Spine’s 80% owned subsidiary, Alphatec Pacific.

 

Intercompany balances and transactions have been eliminated in consolidation.

 

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2005 included in Alphatec’s Amendment No. 6 to Form S-1 filed with the Securities and Exchange Commission on June 2, 2006.

 

The unaudited condensed consolidated statements of operations for the three and six months ended June 30, 2006 include the results of Cortek, Inc. (“Cortek”) from the beginning of the accounting period nearest to its acquisition date (September 9, 2005). See Note 5.

 

3. Unaudited Interim Results

 

The accompanying interim consolidated balance sheet as of June 30, 2006, the statements of operations and cash flows for the three and six months ended June 30, 2006 and the three months ended June 30, 2005, and the period from March 18, 2005 to June 30, 2005 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments necessary to present fairly the Company’s financial position as of those periods.

 

The unaudited combined condensed consolidated statement of operations for six months ended June 30, 2005 is based on the historical consolidated statement of operations of Alphatec Spine, as predecessor, for the period from January 1, 2005 to March 17, 2005 and the historical consolidated statement of operations of Alphatec Holdings, the successor, for the period from March 18, 2005 to June 30, 2005.

 

Operating results for the three and six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2006. The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by generally accepted accounting principles (“GAAP”) for complete financial statements.

 

4. Net Loss Per Share

 

The Company calculates net loss per share in accordance with the Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings per Share . Basic earnings per share (“EPS”) is calculated by dividing the net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company and options are considered to be common stock equivalents and are only included in the calculation of diluted earnings per share when their effect is dilutive.

 

8



 

 

 

 

 

 

 

 

 

 

 

Successor

 

Predecessor

 

 

 

Three Months Ended

 

Six Months Ended

 

March 18,

 

January 1,

 

 

 

June 30,

 

June 30,

 

2005 to

 

2005 to

 

 

 

 

 

 

 

 

 

Combined

 

June 30,

 

March 17,

 

 

 

2006

 

2005

 

2006

 

2005

 

2005

 

2005

 

 

 

 

 

(in thousands, except net loss per share)

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(3,178

)

$

(1,277

)

$

(9,054

)

$

(5,961

)

$

(4,772

)

$

(1,189

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accretion to redemption value of redeemable convertible preferred, Rolling common and Series C common stock

 

(1,508

)

(1,709

)

(3,450

)

(1,940

)

(1,940

)

 

Net loss applicable to common stockholders

 

$

(4,686

)

$

(2,986

)

$

(12,504

)

$

(7,901

)

$

(6,712

)

$

(1,189

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

24,817

 

17,809

 

22,674

 

17,500

 

17,500

 

9,231

 

Weighted average unvested common shares subject to repurchase

 

(1,772

)

 

(1,818

)

 

 

 

Vested common shares outstanding purchased with promissory notes and subject to variable accounting

 

 

 

 

 

 

(20

)

Weighted average common shares outstanding - basic and diluted

 

23,045

 

17,809

 

20,856

 

17,500

 

17,500

 

9,211

 

Net loss per share applicable to common stockholders - basic and diluted

 

$

(0.20

)

$

(0.17

)

$

(0.60

)

$

(0.45

)

$

(0.38

)

$

(0.13

)

 

5. Acquisitions

 

Alphatec Spine, Inc.

 

On March 18, 2005, the Successor acquired all of the outstanding capital stock of Alphatec Spine. The acquisition was funded out of the net proceeds from the Company’s initial capitalization in March 2005. The results of operations of Alphatec Spine have been included in the consolidated financial statements of the Successor from the date of acquisition. The total cost of the acquisition was as follows (in thousands):

 

Cash paid for common stock and stock options

 

$

70,000

 

Debt assumed as a result of acquisition

 

5,458

 

Direct costs

 

1,046

 

Total purchase price

 

$

76,504

 

 

9



 

The purchase price allocation is shown below (in thousands):

 

Cash and cash equivalents

 

$

1,056

 

Accounts receivable

 

4,243

 

Inventories

 

4,206

 

Prepaid expenses and other current assets

 

483

 

Income taxes receivable

 

53

 

Property and equipment, net

 

3,607

 

Other assets

 

100

 

Accounts payable

 

(1,667

)

Accrued and other expenses

 

(4,530

)

Deferred income taxes

 

(3,075

)

 

 

 

 

Net tangible assets

 

4,476

 

Developed product technology

 

13,700

 

Supplier agreement

 

221

 

In-process research and development (IPR&D)

 

3,100

 

Goodwill

 

55,007

 

Total purchase price

 

$

76,504

 

 

In connection with this transaction, the Company conducted a valuation of the acquired assets and assumed liabilities in order to allocate the purchase price in accordance with SFAS No. 141, Business Combinations . Unless otherwise noted below, the fair value of the acquired tangible assets, assumed liabilities and supplier agreement was equal to the Predecessor’s carrying value on March 18, 2005, the date of acquisition. The Company allocated the excess purchase price over the fair value of acquired net tangible and intangible assets to goodwill. A strong scientific employee base having existing relationships with prominent orthopedic surgeons and operations in an attractive market niche were among the factors that contributed to a purchase price resulting in the recognition of goodwill. Goodwill recorded for the acquisition of Alphatec Spine is not deductible for income tax purposes.

 

The developed product technology represented proprietary knowledge that was technologically feasible as of the valuation date, and included all fully functioning products at the date of the valuation. Specifically, developed product technology represented proprietary knowledge related to the following products of the Company: Zodiac Lumbar Fusion and Deformity System, Mirage Spinal Fixation System, ROC Lumbar Plating System, Deltaloc Reveal Anterior Cervical Plate, Solanas Posterior Cervical/Thoracic Fusion, and various cage and bone products. The amount allocated to the developed product technology was assigned based on the estimated net discounted cash flows (income approach) from the related product line on March 18, 2005, the date of acquisition. The developed product technology is being amortized over a useful life of five years.

 

In accordance with SFAS No. 2, Accounting for Research and Development Costs , as clarified by the Financial Accounting Standards Board (“FASB”) Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method, an Interpretation of FASB Statement No. 2, the amounts allocated to in-process research and development (“IPR&D”) expense were determined through established valuation techniques and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and had no alternative future uses.

 

The fair value of the IPR&D was determined using the income approach. Under the income approach, the expected future cash flows from each project under development were estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return were the weighted-average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine technological innovations that were unique, the existence and reliance on core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based on forecasted revenue and costs, taking into account product life cycles, and market penetration and growth rates.

 

10



 

The IPR&D expense includes only the fair value of IPR&D performed as of the respective acquisition dates. The fair value of developed technology was included in identifiable purchased intangible assets. The Company believes the amounts recorded as IPR&D expense, as well as developed technology, represented the fair values and approximated the amounts an independent party would pay for these projects at the time of the respective acquisition dates.

 

As a result of the required adjustment of acquired assets and liabilities to fair value at the date of purchase, using the income approach, the Company increased inventory by $1.1 million over the historical cost. The inventory adjustment resulted in Successor cost of revenues of $1.1 million over what would have been recorded by the Predecessor.

 

Pursuant to the acquisition agreement, the stockholders of the Predecessor put $3.0 million in escrow in order to fund potential indemnification claims for losses incurred by the Company. The Company has filed a claim that it be indemnified for $4.5 million in losses primarily relating to obsolete inventory, certain tax liabilities and uncollectible accounts receivable. There is no assurance whether the Company’s claim will be successful. Any amounts recovered by the Company will be accounted for as a reduction to goodwill.

 

Cortek, Inc.

 

On September 9, 2005, Alphatec Spine acquired certain assets and assumed certain liabilities of Cortek, a manufacturer and distributor of precision milled allograft products, in order to broaden the Company’s product portfolio. The acquisition was funded out of the net proceeds from the Company’s initial capitalization in March 2005. The results of operations of Cortek have been included in the consolidated financial statements of the Successor from the date of acquisition. At December 31, 2005, the total cost of the acquisition was as follows (in thousands):

 

Cash consideration

 

$

6,500

 

Debt assumed as a result of acquisition

 

550

 

Direct costs

 

802

 

Total purchase price

 

$

7,852

 

 

The purchase price allocation is shown below (in thousands):

 

Accounts receivable

 

$

1,608

 

Inventories

 

2,213

 

Prepaid expenses and other current assets

 

100

 

Property and equipment, net

 

266

 

Other assets

 

57

 

Accounts payable

 

(955

)

Accrued expenses

 

(1,377

)

Net tangible assets

 

1,912

 

Goodwill

 

5,940

 

Total purchase price

 

$

7,852

 

 

In connection with this transaction, the Company conducted a valuation of the acquired assets and assumed liabilities in order to allocate the purchase price in accordance with SFAS No. 141. The Company has allocated the excess purchase price over the fair value of acquired net tangible assets to goodwill. The enhancement of the Company’s existing portfolio of spine fusion products with a complementary offering of precision milled allograft products was the primary factor that contributed to a purchase price resulting in the recognition of goodwill. Goodwill recorded for this acquisition will be deducted on a straight-line basis for income tax purposes over 15 years.

 

As a result of the required adjustment of acquired assets and liabilities to fair value at the date of purchase, using the income approach, the Company increased inventory by $0.4 million over the historical cost. The increased inventory value was recorded as cost of revenues as the related products were sold. As of December 31, 2005 and June 30, 2006, respectively, $0.2 million and $0 of this amount remained in ending inventory.

 

During the fourth quarter of 2005, the Company revised the purchase price allocation and reduced inventory by $0.9 million to conform Cortek’s accounting for inventory to Alphatec’s accounting for inventory.

 

11



 

During the six months ended June 30, 2006, the preliminary valuation of certain liabilities was adjusted by $0.05 million, resulting in a decrease of goodwill of the same amount.

 

Ishibe Medical Co, Ltd.

 

On November 1, 2005, Alphatec Pacific acquired all of the outstanding capital stock of Ishibe Medical Co, Ltd., a medical devices distributor headquartered in Sapporo, Japan. The direct cost of the acquisition was less than $0.3 million. The acquisition resulted in an increase to intangibles of approximately $1.1 million for distribution rights which are being amortized over three years. The results of operations have been included in the consolidated financial statements from the date of acquisition.

 

Pro Forma Statement of Operations

 

The following unaudited pro forma financial information reflects the consolidated results of operations as if the acquisition of Alphatec Spine and Cortek had occurred at the beginning of the period presented. The unaudited pro forma financial data is presented and is not necessarily indicative of the Company’s results of operations that might have occurred had the transactions been completed at the beginning of the period presented, and do not purport to represent what the Company’s consolidated results of operations might be for any future period.

 

(in thousands, except net loss per share)

 

Six Months
Ended
June 30, 2005

 

Revenues

 

$

19,775

 

Net loss

 

(7,021

)

Accretion to redemption value of redeemable convertible preferred, Rolling common and Series C common stock

 

(1,940

)

Net loss applicable to common stockholders

 

$

(8,961

)

 

 

 

 

Net loss per share - basic and diluted

 

$

(0.51

)

 

 

 

 

Weighted average shares outstanding - basic and diluted

 

17,500

 

 

The pro forma results for 2005 include nonrecurring charges for the write-off of IPR&D of $3.1 million and the step up in the basis of the inventory of $1.1 million directly related to the acquisition as if they had occurred at the beginning of each period presented.

 

Buyback of Distribution Rights

 

On August 11, 2005, the Company paid $3.1 million to repurchase its distribution rights in Japan. The transaction was entirely financed by Alphatec Pacific’s current Chairman, President and Chief Executive Officer in return for the issuance of a note payable that was to be repaid in 18 equal monthly installments of $0.2 million (18.46% effective interest rate to scheduled maturity), beginning December 1, 2005. As additional compensation for making the loan to the Company, the Company granted Alphatec Pacific’s Chairman, President and Chief Executive Officer a 20% interest in Alphatec Pacific, which had an estimated value of $0.6 million. This amount was recorded as debt issuance cost in the accompanying balance sheet. The note, plus accrued interest, totaling $3.0 million, was paid in full from the initial public offering proceeds in June 2006. See Note 15.

 

12



 

6. Stock-Based Compensation

 

Adoption of SFAS 123(R)

 

Effective January 1, 2006. the Company adopted the provisions of SFAS No. 123(R), Share-Based Payment using the prospective transition method and therefore, prior period results will not be restated. SFAS No 123(R) supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock issued to Employees , and related interpretations, and revises guidance in SFAS No. 123, Accounting for Stock-Based Compensation . Under this transition method, the compensation cost related to all equity instruments granted prior to, but not yet vested as of the adoption date is recognized based on the grant-date fair value, which is estimated in accordance with the original provisions of SFAS No. 123. Compensation costs related to all equity instruments granted after January 1, 2006 are recognized at grant-date fair value of the awards in accordance with the provisions of SFAS No. 123(R). Additionally, under the provisions of SFAS No. 123(R), the Company is required to include an estimate of the number of the awards that will be forfeited in calculating compensation costs, which is recognized over the requisite service period of the awards on a straight-line basis.

 

Valuation of Stock Option Awards

 

The assumptions used to compute the share-based compensation costs for the stock options granted during the three and six month periods ended June 30, 2006 and 2005 are as follows:

 

 

 

 

 

 

 

 

 

 

 

Successor

 

Predecessor

 

 

 

Three Months Ended

 

Six Months Ended

 

March 18,

 

January 1,

 

 

 

June 30,

 

June 30,

 

2005 to

 

2005 to

 

 

 

 

 

 

 

 

 

Combined

 

June 30,

 

March 17,

 

 

 

2006

 

2005

 

2006

 

2005

 

2005

 

2005

 

Employee Stock Options

 

 

 

 

 

 

 

 

 

 

 

 

 

Risk-free interest rate

 

5.1

%

%

4.6 - 5.1

%

%

%

%

Expected dividend yield

 

%

%

%

%

%

%

Weighted average expected life

 

6.5

 

 

6.5

 

 

 

 

Volatility

 

65

%

%

65

%

%

%

%

Forfeiture rate

 

15

%

%

15

%

%

%

%

 

No weighted average assumptions are listed for the period from January 1, 2005 to March 17, 2005 due to the fact that no equity instruments were issued during that period. No weighted average assumptions are listed for the period from March 18, 2005 to June 30, 2005 since no significant equity instruments issued to employees during the period were issued with exercise prices greater than $0.002, and as such, use of the Minimum Value pricing model did not result in significant additional stock-based compensation expense over the amount recorded.

 

The risk-free interest rate assumption was based on the United States Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. The assumed dividend yield was based on the Company’s expectation of not paying dividends in the foreseeable future. The weighted average expected life of options was calculated using the simplified method as prescribed by the SEC’s Staff Account Bulletin (“SAB”) No. 107. This decision was based on the lack of relevant historical data due to the Company’s limited historical experience. In addition, due to the Company’s limited historical data, the estimated volatility also reflects the application of SAB No. 107, incorporating the historical volatility of comparable companies whose share prices are publicly available.

 

The weighted average grant-date fair value of stock options granted during the three and six months ended June 30, 2006 was $6.06 and $4.99 respectively.

 

13



 

Compensation Costs

 

Results of operations for the three and six months ended June 30, 2006 include stock-based compensation costs of $2.2 million and $3.5 million, respectively. The compensation cost that has been included in our condensed consolidated statement of operations for all stock-based compensation arrangements is detailed as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Successor

 

Predecessor

 

 

 

Three Months Ended

 

Six Months Ended

 

March 18,

 

January 1,

 

 

 

June 30,

 

June 30,

 

2005 to

 

2005 to

 

 

 

 

 

 

 

 

 

Combined

 

June 30,

 

March 17,

 

 

 

2006

 

2005

 

2006

 

2005

 

2005

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

215

 

$

 

$

368

 

$

 

$

 

$

 

Research and development

 

206

 

 

262

 

37

 

 

37

 

Sales and marketing

 

269

 

 

516

 

980

 

 

980

 

General and administrative

 

1,514

 

 

2,379

 

1,143

 

 

1,143

 

Total

 

$

2,204

 

$

 

$

3,525

 

$

2,160

 

$

 

$

2,160

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net stock-based compensation expense, per common share—basic and diluted

 

$

0.10

 

$

 

$

0.17

 

$

0.12

 

$

 

$

0.23

 

 

Total unrecognized share-based compensation costs related to non-vested stock options granted during the three and six months ended June 30, 2006 was approximately $2.3 million and $2.3 million, respectively, which related to 0.4 million and 0.4 million shares, respectively. This unrecognized cost is expected to be recognized over a weighted average period of approximately 5 years. Unrecognized share-based compensation related to non-vested stock and option awards granted prior to January 1, 2006 was approximately $15.1 million at June 30, 2006.

 

Adjusted Net Loss Information

 

In addition, prior to the adoption of SFAS No. 123(R), the Company presented deferred compensation as a separate component of stockholders’ equity. In accordance with the provisions of SFAS No. 123(R), on January 1, 2006, the Company reclassified deferred compensation against additional paid-in capital and retained earnings.

 

Prior to January 1, 2006, the Company applied the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation –an interpretation of APB Opinion No. 25 , to account for its equity-based awards to employees and directors. Under this method, if the exercise price of the award equaled or exceeded the fair value of the underlying stock on the measurement date, no compensation expense was recognized. The measurement date was the date on which the final number of shares and exercise price were known and was generally the grant date for awards to employees and directors. If the exercise price of the award was below the fair value of the underlying stock on the measurement date, then compensation cost was recorded, using the intrinsic-value method, and was generally recognized in the statements of operations over the vesting period of the award.

 

The following table illustrates the effect on net loss as if the fair-value-based method had been applied to all outstanding and unvested awards in each period. For purposes of disclosures required by SFAS No. 123, the estimated fair value of the options is amortized on a straight-line basis over the vesting period. Because additional option grants are expected in the future, the pro forma disclosures below are not representative of the effects of option grants on reported net operating results in future periods. The period from March 18, 2005 to June 30, 2005 is not presented below since the pro forma net loss does not materially differ from the reported net loss. Disclosures for the three and six months ended June 30, 2006 are not presented in the following table because stock-based compensation was accounted for under SFAS 123(R)’s fair-value method during those periods.

 

14



 

 

 

Predecessor

 

 

 

January 1, 2005 to

 

(in thousands, except net loss per share)

 

March 17, 2005

 

Net loss attributable to common stockholders as reported

 

$

(1,189

)

Add: Stock-based employee compensation expense included in net loss

 

1,971

 

Deduct: Stock-based employee compensation expense determined under fair value method for all awards

 

(2,004

)

Pro forma net loss attributable to common stockholders

 

$

(1,222

)

Basic and diluted net loss per share as reported

 

$

(0.13

)

Basic and diluted net loss per share pro forma

 

$

(0.13

)

 

Equity instruments issued to non-employees are recorded at their fair value as determined in accordance with SFAS No. 123 and Emerging Issues Task Force (“EITF”) Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods and Services , and are periodically revalued as the equity instruments vest and are recognized as expense over the related service period. In connection with the sale of 0.1 million shares of common stock to non-employees during the period from March 18, 2005 to June 30, 2005, the Company recorded stock-based compensation of $39,353.

 

7. Stock Options and Restricted Shares

 

Stock-Based Employee Compensation Plan

 

Upon the effectiveness of the Company’s initial public offering, the Company adopted the Amended and Restated 2005 Employee, Director and Consultant Stock Plan (“the Plan”) and reserved 6.4 million shares of common stock for issuance pursuant to the plan. The plan contains an “evergreen” provision, which allows for an annual increase in the number of shares available for issuance under the Plan on the first day of each fiscal year during the period beginning on the first day of fiscal year 2007, and ending on the second day of fiscal year 2015. The annual increase in the number of shares shall be equal to the lowest of (i) 1.6 million shares, (ii) 5% of the number of shares of our common stock outstanding on the first day of the applicable fiscal year, and (iii) an amount determined by our board of directors. At June 30, 2006, 2.0 million shares of our common stock were reserved for future issuance upon the exercise of outstanding options and future vesting of restricted shares and 4.4 million shares were available for future grants under the Plan.

 

Summary of Stock Options

 

A summary of the Company’s stock options outstanding under the Plan as of June 30, 2006, and the activity during the six months then ended, are as follows (in thousands, except per share amounts):

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

 

 

Weighted-

 

Remaining

 

 

 

 

 

 

 

Average

 

Contractual

 

Aggregate

 

 

 

 

 

Exercise

 

Term (in

 

Intrinsic

 

 

 

Shares

 

Price

 

Years)

 

Value

 

Options Outstanding at December 31, 2005 as adjusted for 3.57 stock split on 5/18/06

 

117

 

$

0.93

 

9.71

 

 

 

Options granted

 

438

 

$

4.99

 

 

 

 

 

Options exercised

 

 

 

 

 

 

 

 

 

Options forfeited

 

(36

)

$

2.46

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options outstanding at June 30, 2006

 

519

 

$

4.14

 

9.55

 

$

8.17

 

 

15



 

June 30, 2006

 

Options outstanding

 

Options exercisable

 

 

 

 

 

Weighted average

 

 

 

 

 

Weighted

 

 

 

 

 

remaining

 

Weighted

 

 

 

average

 

 

 

Number

 

contractual life (in

 

average

 

Number

 

exercise

 

Exercise price

 

outstanding

 

years)

 

exercise price

 

exercisable

 

price

 

$

0.001

 

89

 

9.15

 

$

0.001

 

 

$

 

$

4.76

 

383

 

9.61

 

$

4.76

 

 

$

 

$

4.76

 

18

 

9.76

 

$

4.76

 

 

$

 

$

8.07

 

29

 

9.97

 

$

8.07

 

 

$

 

 

Total

 

519

 

9.55

 

$

4.14

 

 

 

 

 

 

 

Disclosure Pertaining to All Share-Based Compensation Plans

 

Of the options outstanding at June 30, 2006, 0.4 million of the shares are expected to vest, and have a weighted average exercise price of $4.07 and an intrinsic value of $0.8 million. Aggregate intrinsic value is the sum of the amounts by which the quoted market price of the Company’s stock exceeded the exercise price of the options at June 30, 2006 (“in-the-money-options”). The weighted-average grant-date fair value of options granted during the three and six months ended June 30, 2006 was $6.06 and $4.99, respectively. There were no options granted during the three and six months ended June 30, 2005. There were no options exercised during the three and six months ended June 30, 2006 and June 30, 2005.

 

As of June 30, 2006, $17.4 million of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Plan is expected to be recognized over a weighted-average period of 2.3 years.

 

8. Cash Equivalents

 

Cash equivalents are short-term, highly liquid investments and consist of investments in money market funds and commercial paper with maturities of three months or less at the time of purchase.

 

16



 

9. Inventories

 

Inventories, net consist of the following (in thousands):

 

 

 

June 30, 2006

 

December 31, 2005

 

 

 

Gross

 

Excess &
Obsolete

 

Net

 

Gross

 

Excess &
Obsolete

 

Net

 

Raw materials

 

$

2,093

 

$

(424

)

$

1,669

 

$

1,482

 

$

(536

)

$

946

 

Work-in process

 

1,273

 

 

1,273

 

682

 

 

682

 

Finished goods

 

17,217

 

(9,534

)

7,683

 

14,380

 

(7,550

)

6,830

 

Total Inventories, net

 

$

20,583

 

$

(9,958

)

$

10,625

 

$

16,544

 

$

(8,086

)

$

8,458

 

 

The Company recorded charges related to the excess and obsolete reserve to cost of revenues of $0.8 million and $0.1 million for the three months ended June 30, 2006 and June 30, 2005, respectively. The Company recorded charges to cost of revenues of $1.7 million and $0.1 million for the six months ended June 30, 2006 and June 30, 2005, respectively.

 

10. Comprehensive Income (Loss)

 

The Company has adopted SFAS No. 130, Reporting Comprehensive Income , which requires that all components of comprehensive income, including net income, be reported in the consolidated financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net income (loss) and other comprehensive income (loss), including foreign currency translation adjustments and unrealized gains and losses on investments, are reported, net of their related tax effect, if any, to arrive at comprehensive income (loss).

 

Comprehensive loss consists of the following components (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Successor

 

Predecessor

 

 

 

Three Months Ended

 

Six Months Ended

 

March 18,

 

January 1,

 

 

 

June 30,

 

June 30,

 

2005 to

 

2005 to

 

 

 

 

 

 

 

 

 

Combined

 

June 30,

 

March 17,

 

 

 

2006

 

2005

 

2006

 

2005

 

2005

 

2005

 

Net loss, as reported

 

$

(3,178

)

$

(1,277

)

$

(9,054

)

$

(5,961

)

$

(4,772

)

$

(1,189

)

Foreign currency translation adjustment

 

(34

)

(10

)

165

 

(18

)

(14

)

(4

)

Comprehensive loss

 

$

(3,212

)

$

(1,287

)

$

(8,889

)

$

(5,979

)

$

(4,786

)

$

(1,193

)

 

11. Segment and Geographical Information

 

The Company has adopted the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information . SFAS No. 131 requires public companies to report financial and descriptive information about their reportable operating segments. The Company identifies its operating segments based on how management internally evaluates separate financial information, business activities and management responsibility. The Company believes it operates in a single business segment.

 

For the three and six months ended June 30, 2006 and June 30, 2005, the Company had no single surgeon, hospital, or surgical center representing greater than 10% of consolidated revenues.

 

17



 

During the three and six months ended June 30, 2006 and June 30, 2005, the Company operated in two geographic locations, the United States and Asia. Net revenues, attributed to the geographic location of the customer, were as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

Predecessor

 

 

 

Three Months Ended

 

Six Months Ended

 

Successor

 

January 1,

 

 

 

June 30,

 

June 30,

 

March 18,

 

2005 to

 

 

 

 

 

 

 

 

 

Combined

 

2005 to June

 

March 17,

 

 

 

2006

 

2005

 

2006

 

2005

 

30, 2005

 

2005

 

United States

 

$

15,871

 

$

8,256

 

$

30,322

 

$

14,587

 

$

9,092

 

$

5,495

 

Asia

 

3,551

 

64

 

7,129

 

634

 

79

 

555

 

Total consolidated revenues

 

$

19,422

 

$

8,320

 

$

37,451

 

$

15,221

 

$

9,171

 

$

6,050

 

 

Total assets by region were as follows (in thousands):

 

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

United States

 

$

130,714

 

$

100,782

 

Asia

 

8,765

 

8,357

 

Total consolidated assets

 

$

139,479

 

$

109,139

 

 

12. Related Party Transactions

 

Predecessor Transactions

 

During the period from January 1, 2005 to March 17, 2005, the Predecessor’s majority stockholder and Chief Executive Officer sold 0.2 million shares of common stock to certain employees at $1.50 per share which were subsequently determined to be less than the fair value of $6.70 at the date of the transaction. Accordingly, the Company recorded a stock-based compensation charge of $0.8 million in the accompanying statement of operations.

 

Successor Transactions

 

The Company paid an advisory fee of $1.1 million to HealthpointCapital Advisors, LLC, a registered broker dealer that is an affiliate of our principal stockholder, HealthpointCapital Partners, L.P. (“HealthpointCapital”)  related to the financing of the acquisition of the Predecessor during the period ended December 31, 2005. In addition, the Company paid a finders’ fee to HealthpointCapital of $0.5 million during the period ended December 31, 2005. The Company incurred costs of $0, $0.6 million and $0.3 million to Foster Management Company (an entity owned by the Company’s Chairman and also a significant equityholder of HealthpointCapital, LLC, an affiliate of HealthpointCapital) for travel expenses, including the use of Foster Management Company’s airplane for the period from March 18, 2005 to March 31, 2005, the period from March 18, 2005 to December 31, 2005 and the six months ended June 30, 2006, respectively.

 

During the six months ended June 30, 2006, the Company agreed to pay HealthpointCapital, LLC an advisory fee of $1.0 million plus out-of-pocket expenses for services provided to the Company in connection with the completion of the Company’s initial public offering pursuant to an oral arrangement with HealthpointCapital, LLC. Included in accrued expenses at June 30, 2006 is $0.1 million for out-of-pocket expenses.

 

In connection with the Successor’s repurchase of certain distribution rights in Japan, the Company borrowed $3.1 million from Alphatec Pacific’s Chairman, President and Chief Executive Officer in exchange for a note payable which bears an effective interest rate to scheduled maturity of 18.46% and a 20% ownership interest in Alphatec Pacific. For the period from March 18, 2005 to December 31, 2005 and the six months ended June 30, 2006, the Company recorded interest expense totaling approximately $0.2 million and $0.3 million, respectively, under this note. The note, plus accrued interest, totaling $3.0 million, was paid in full from the initial public offering proceeds in June 2006.

 

13. Recent Accounting Pronouncements

 

In June 2006, the FASB issued Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 . This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and

 

18



 

provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently assessing the impact of the Interpretation on its financial statements.

 

14. Acquired Intangibles

 

Acquired intangibles consist of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Useful lives

 

June 30, 2006

 

December 31, 2005

 

 

 

(in years)

 

 

 

 

 

Developed product technology

 

5

 

$

13,700

 

$

13,700

 

Distribution rights

 

3

 

2,038

 

2,038

 

Supply agreement

 

10

 

225

 

225

 

 

 

 

 

15,963

 

15,963

 

Less accumulated amortization

 

 

 

(3,989

)

(2,319

)

Total

 

 

 

$

11,974

 

$

13,644

 

 

Amortization expense for intangible assets for the six months ended June 30, 2006 was $1.7 million and for the period of March 18, 2005 to December 31, 2005 was $2.3 million. The Company had no significant amortization expense for the period January 1, 2005 to March 17, 2005 and the period from March 18, 2005 to March 31, 2005.

 

15. Commitments and Contingencies

 

Debt

 

On January 24, 2006, Alphatec Spine entered into a two-year term, $10.0 million revolving line of credit with Bank of the West to provide the working capital necessary to support the expansion of the Company’s distribution channels. Borrowing under the financing arrangement will bear interest at the bank’s prime rate or LIBOR plus 2.25%, with interest payable monthly. Availability under the revolving line of credit is subject to a borrowing base equal to 80% of eligible accounts receivable and 20% to 50% of eligible inventory, subject to certain limitations. Under the terms of this credit facility, Alphatec Spine is required to make monthly interest payments and is subject to certain covenants, which include among other things, prohibiting a net loss (as defined in the credit agreement) for fiscal 2005 in excess of $2.0 million, requiring a specified ratio of debt to cash flow and a specified ratio of debt to tangible net worth plus subordinated debt, requiring certain levels of profitability (as defined in the credit agreement) and restricting certain mergers and acquisitions without prior approval of the bank. In addition, this credit facility prohibits Alphatec Spine from declaring or paying cash dividends. The financing is collateralized by substantially all of the assets and capital stock of Alphatec Spine and is guaranteed by the Company. As of June 30, 2006 there were no outstanding borrowings under this line of credit.

 

During the second quarter of 2006, Alphatec Spine entered into term loans with General Electric Capital Corporation (“GECC”), for approximately $2.7 million in order to finance certain previously purchased plant and office equipment. The loan terms are three years, bear interest from 11.23% to 11.42%, are secured by certain assets of Alphatec Spine, may not be prepaid without the consent of GECC and are guaranteed by Alphatec Holdings. Under the terms of these loans, Alphatec Spine is required to make 36 equal monthly principal and interest payments of $0.1 million and is subject to certain covenants, which include, among other things, prohibiting a net loss (as defined in the credit agreement by and between Alphatec Spine and Bank of the West) in any two consecutive quarters, requiring a specified ratio of debt to cash flow and a specified ratio of debt to tangible net worth, requiring certain levels of profitability and restricting certain mergers and acquisitions without prior approval from GECC. If Alphatec Spine fails to satisfy these covenants and fails to cure any breach of these covenants within a specified number of days after receipt of notice, or fails to pay interest or principal under the loan when due, GECC could accelerate the entire amount borrowed, which would also trigger a default under Alphatec Spine’s credit facility from Bank of the West. Similarly, the GECC loan has cross default provisions relating to defaults under any material obligation of Alphatec Spine for other debt, deferred purchase price payments for property and lease payments. We are currently in compliance with the covenants under the GECC loan. Alphatec Spine obtained a waiver from Bank of the West in order to obtain the GECC loan.

 

Alphatec Pacific has a $1.9 million credit facility with a Japanese bank, under which $1.7 million and $1.4 million were outstanding at June 30, 2006 and December 31, 2005, respectively. Under the terms of the line of credit, borrowings are due six months from the date of borrowing and bear interest at 1.88%. Under the terms of the credit facility Alphatec Pacific is required to make monthly interest payments. The credit facility is secured by a deposit in the lending bank of approximately $2.0 million by Alphatec Pacific’s Chairman, President and Chief Executive Officer.

 

19



 

Supply Agreements

 

In July 2006, Alphatec Spine entered into a 30-month license agreement to sell the product of a third party under Alphatec Spine’s private label. The total minimum purchase commitment over the life of the contract is $8.0 million.

 

In March 2006, Alphatec Spine entered into a four-year agreement to sell the product of a third party under Alphatec Spine’s private label. The total minimum purchase commitment over the life of the contract is $6.0 million.

 

In February 2006, Alphatec Spine entered into a three-year non-exclusive license agreement to sell the product of a third party under Alphatec Spine’s private label. The total minimum purchase commitment over the life of the contract is $1.9 million.

 

In October 2004, the Predecessor entered into a ten-year agreement with one of its principal suppliers. This agreement fixed the price of materials with the supplier for the first 18 months and limits the annual price increase to eight percent for the remainder of the term of the agreement and requires three payments totaling $225,000. The Predecessor made a $75,000 payment in November 2004 and the Company made a $75,000 payment in September 2005 and will make one additional annual payment of $75,000 in September 2006. The $225,000 was recorded as an intangible asset in the accompanying balance sheet.

 

Leases

 

The Company leases certain equipment under capital leases that expire on various dates through 2010. The Company also leases its buildings and certain equipment and vehicles under operating leases that expire on various dates through 2010. Future minimum annual lease payments under such leases as of June 30, 2006 are as follows (in thousands):

 

Year Ending December 31,

 

Operating

 

Capital

 

2006 - 6 months

 

$

734

 

$

307

 

2007

 

1,225

 

606

 

2008

 

784

 

505

 

2009

 

629

 

340

 

2010 and beyond

 

565

 

13

 

 

 

$

3,937

 

1,771

 

 

 

 

 

 

 

Less: amount representing interest

 

 

 

(145

)

Present value of minimum lease payments

 

 

 

1,626

 

Current portion of capital leases

 

 

 

(530

)

Capital leases, less current portion

 

 

 

$

1,096

 

 

Rent expense under operating leases for the three months ended June 30, 2006 and June 30, 2005 were $0.4 million and $0.1 million respectively. Rent expense under operating leases for the six months ended June 30, 2006 and June 30, 2005 were $0.8 million and $0.2 million respectively.

 

Litigation

 

The Company is involved from time to time in litigation or claims arising in the ordinary course of its business. As of June 30, 2006 the Company had a reserve for litigation costs of $0.8 million. The accrual amounts are based on either a settlement offer from the plaintiff or the agreed upon settlement, or in some cases, an estimation, based upon what our management believes is the low-range of potential liability.

 

On June 26, 2006, Biedermann Motech GmbH and Depuy Spine, Inc. filed suit for patent infringement against a number of companies including Alphatec Spine. The complaint, filed in United States District Court, District of Massachusetts, relates to U.S. Patent No. 5,207,678. Biedermann Motech owns the patent and Depuy is the exclusive licensee of the patent. In the complaint, the plaintiffs sought monetary damages related to such alleged infringement. On July 21, 2006, Biedermann Motech and Depuy filed a motion of preliminary injunction seeking to enjoin Alphatec from further sales and manufacture of its Zodiac and Solanas products pending the outcome of litigation. Alphatec responded to this complaint on July 31, 2006 and filed counterclaims against Depuy related to actions taken by Depuy’s sales force related to this litigation. In its counterclaim, Alphatec seeks to have Depuy’s sales force cease and desist its actions related to this litigation and to invalidate the 678 patent. Alphatec does not believe that any of its products infringe on this patent and intends to vigorously defend itself against this complaint. The ultimate impact on the financial statements cannot be determined at this time.

 

20



 

On April 12, 2006, the Company and HealthpointCapital, its majority stockholder, and its affiliate, HealthpointCapital, LLC, were served with a complaint by Drs. Darryl Brodke, Alan Hilibrand, Richard Ozuna and Jeffrey Wang (the claimant surgeons) in the Superior Court of California in the County of Orange, claiming, among other things, that, pursuant to certain contractual arrangements Alphatec Spine allegedly entered into with the claimant surgeons in 2001, the Company was required to pay the claimant surgeons quarterly royalties in an aggregate amount of 6% of the net sales of polyaxial screws, which the claimant surgeons allege were developed with their assistance prior to the cessation of such development activities in March 2002. The Company first began to sell polyaxial screws in 2003 and has continued to sell them through the date of this report. In June of 2006, the parties to this litigation agreed to pursue mediation in an attempt to mediate a resolution to this matter. Alphatec does not believe that any of the claimant surgeons are entitled to any royalty amounts and intends to vigorously defend itself against this complaint, however the Company cannot predict the outcome to this matter or the impact on the financial statements, if any.

 

On February 2, 2006, Alphatec Spine filed a joint complaint with Alphatec Spine’s President and CEO, Ronald G. Hiscock, in California State Superior Court against Benchmark Medical, Inc. and Benchmark Medical Holdings, Inc., in connection with Benchmark’s failure to pay Mr. Hiscock certain amounts due to him pursuant to his severance agreement with Benchmark. In addition, the complaint sought a declaratory judgment affirming Alphatec Spine’s ability to recruit and hire former Benchmark employees. In March 2006, Benchmark filed a complaint against Mr. Hiscock and the Company’s Senior Vice President and Chief Administrative Officer, Vicky Romanoski, in Pennsylvania State court in which Benchmark claimed that each of them violated the terms of their respective severance agreements with Benchmark and sought to have the matter litigated in Pennsylvania rather than California. On June 21, 2006, the Company executed a settlement agreement with Benchmark that relieves all parties of all obligations related to prior severance and promissory note agreements between Benchmark and Mr. Hiscock and Ms. Romanoski. The agreement also settles litigation brought by Alphatec and Benchmark against one another related to these matters.

 

On or about November 22, 2005, the Company, among other entities, was served with a complaint by Abbott Spine, Inc. in the United States District Court for the District of Arizona. The complaint alleged that Alphatec Spine tortiously interfered with a contract that Abbott had with one of its independent sales agents and tortiously interfered with Abbott’s customer relationships in Arizona. In the complaint, Abbott sought monetary damages and to have Alphatec cease and desist the alleged interference. On August 4, 2006, the matter was settled pursuant to a settlement agreement. The settlement agreement ends the litigation brought by Abbott against all parties related to these matters.

 

Put Right

 

On August 11, 2005, the Company entered into a Stock Purchase Agreement with Alphatec Pacific’s Chairman, President and Chief Executive Officer in connection with the financing to repurchase certain distribution rights in Japan. The Stock Purchase Agreement provided the related party with the option to purchase 40 shares of the then outstanding 200 shares of Alphatec Pacific for $1.00, which was exercised on August 11, 2005. Under the terms of the Stock Purchase Agreement, Alphatec Pacific’s Chairman, President and Chief Executive Officer has the right to require the Company to repurchase the shares beginning one year from the completion of an initial public offering by the Company. In addition, the Company has an obligation to repurchase those shares upon certain changes of control of Alphatec Holdings, Alphatec Spine or Alphatec Pacific or upon termination of the employment of the stockholder. The repurchase price is equal to the sum of 60% of annualized revenue from the sale of spine products and 20% of annualized revenues from the sales of other orthopedic device revenues by Alphatec Pacific, except in the event of a change of control of Alphatec Pacific, where it will be equal to a proportionate share of the price paid for Alphatec Pacific.

 

The fair value of the 40 shares was established on August 11, 2005 in the amount of $0.6 million and was recorded as minority interest and as debt issuance cost for the note payable to Alphatec Pacific’s Chairman, President and Chief Executive Officer. The debt issuance cost was being amortized using the interest method over the life of the related note to interest expense. In June 2006, the Company paid off the note financing its repurchase of the distribution rights in Japan with proceeds from its initial public offering. The remaining balance of debt issuance costs was expensed at that time. Interest expense of $0.4 million and $0.5 million was recorded for amortization of debt issuance cost for the three months and six months ended June 30, 2006 respectively.

 

Subsequent to the original valuation on August 11, 2005, the value of the put right is being accounted for under SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity . In accordance with SFAS No. 150, the put right is classified as a liability and is represented by the minority interest in the accompanying consolidated balance sheets. The value of the put right at any reporting date is remeasured at the amount of cash that would be paid under the terms of the agreement as if the settlement occurred on that reporting date and recognizes the amount of the change from the previous reporting date as interest cost. In addition to the interest cost recorded for the change in the value of the put right, the Company consolidates 100% of Alphatec Pacific’s operations. Interest expense (inclusive of the debt issuance cost mentioned above) of $0.7 million and $1.9 million respectively, was recorded for the three months and six months ended June 30, 2006.

 

21



 

Royalties

 

The Company has entered into various intellectual property agreements requiring the payment of royalties based on products sold. These royalties primarily relate to products sold by Alphatec Spine and are calculated either as a percentage of net revenue or on a per unit basis. Royalties are included on the accompanying consolidated statement of operations as a component of cost of revenues.

 

16. Redeemable Preferred Stock and Stockholders’ Equity

 

Redeemable convertible preferred stock

 

In March 2005, the Company was capitalized through the sale of preferred stock units, consisting of shares of redeemable convertible preferred stock and common stock, and the sale of Rolling common stock and Series C common stock. The immediate redemption value of the redeemable convertible preferred stock was equal to the unit price of the preferred stock unit and accordingly, none of the proceeds were allocated to the shares of common stock. The tables below summarize the number of shares of redeemable convertible preferred stock and common stock comprising each unit, as well as the number of shares of Rolling common and Series C common stock, the gross proceeds received by the Company for, and the aggregate carrying value of, the redeemable convertible preferred stock, Rolling common and Series C common stock at December 31, 2005 and June 7, 2006 (in thousands):

 

December 31, 2005

 

Unit

 

Preferred
shares

 

Common
shares

 

Gross
proceeds

 

 

 

 

 

 

 

 

 

Series A

 

1,539

 

678

 

$

15,390

 

Series A-1

 

2,903

 

1,278

 

29,035

 

Series B

 

4,000

 

3,259

 

40,000

 

Rolling common

 

200

 

 

4,546

 

Series C common

 

131

 

 

4,359

 

 

 

8,773

 

5,215

 

$

93,330

 

Gross issuance costs

 

 

 

 

 

(1,517

)

Accretion to redemption value through December 31, 2005

 

 

 

 

 

5,682

 

Beneficial conversion feature of Series C common stock

 

 

 

 

 

1,918

 

Carrying value at December 31, 2005

 

 

 

 

 

$

99,413

 

 

June 7, 2006

 

Unit

 

Preferred
shares

 

Common
shares

 

Gross
proceeds

 

 

 

 

 

 

 

 

 

Series A

 

1,539

 

678

 

$

15,390

 

Series A-1

 

2,903

 

1,278

 

29,035

 

Series B

 

4,000

 

3,259

 

40,000

 

Rolling common

 

200

 

 

4,546

 

Series C common

 

139

 

 

4,601

 

 

 

8,781

 

5,215

 

$

93,572

 

Gross issuance costs

 

 

 

 

 

(1,351

)

Accretion to redemption value through June 7, 2006

 

 

 

 

 

8,845

 

Beneficial conversion feature of Series C common stock

 

 

 

 

 

2,030

 

Liquidation and redemption value at June 7, 2006

 

 

 

 

 

$

103,096

 

 

As part of the Company’s initial public offering completed in June 2006, all of our redeemable convertible preferred stock was redeemed for a combination of $35.2 million cash, 3.3 million shares of new redeemable preferred stock and 3.9 million of new shares of common stock.

 

22



 

Stock Split

 

On May 3, 2006, the Company’s board of director’s approved a 3.57-for-1 stock split in the form of a dividend of 2.57 shares of the Company’s outstanding common stock. The accompanying consolidated financial statements give retroactive effect to the stock split for all periods presented. This resulted in the issuance of 15.5 million shares of additional common stock to our common stockholders.

 

Initial Public Offering

 

In June 2006, the Company completed an initial public offering whereby it sold 9.3 million shares of common stock at $9.00 per share and received net proceeds of $70.2 million (after underwriting discounts and commissions and estimated offering costs). The existing classes of common stock were also converted into a single class of common stock.

 

The following schedule summarizes the changes in the capital stock and additional paid in capital (in thousands):

 

 

 

Common Stock

 

 

 

 

 

Series A

 

Series A-1

 

Series B

 

New Common Stock

 

Additional

 

 

 

 

 

$.0001

 

 

 

$.0001 Par

 

 

 

$.0001

 

 

 

$.0001

 

Paid-in

 

 

 

Shares

 

Par Value

 

Shares

 

Value

 

Shares

 

Par Value

 

Shares

 

Par Value

 

Capital

 

Balance, March 17, 2005

 

 

$

 

 

$

 

 

$

 

 

$

 

$

 

Sales of stock

 

678

 

 

1,855

 

 

3,259

 

 

 

 

8

 

Repurchased stock

 

 

 

(21

)

 

 

 

 

 

 

Shares outstanding at December 31, 2005

 

678

 

 

1,834

 

 

3,259

 

0

 

 

 

8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales of stock

 

 

 

2

 

 

 

 

 

 

 

Repurchased stock

 

 

 

(64

)

 

 

 

 

 

 

Stock split

 

1,742

 

 

4,555

 

 

8,375

 

1

 

 

 

 

Dividend paid in stock

 

658

 

 

1,267

 

 

1,711

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redemption and conversion of old common stock to new common stock

 

(3,078

)

 

(7,594

)

 

(13,345

)

(1

)

24,016

 

2

 

37,216

 

Conversion of rolling and Series C common to new common stock

 

 

 

 

 

 

 

1,483

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Initial public offering, net

 

 

 

 

 

 

 

9,300

 

1

 

70,236

 

Accretion amortization

 

 

 

 

 

 

 

 

 

 

 

1,507

 

New redeemable preferred stock adjusted to fair value

 

 

 

 

 

 

 

 

 

 

 

 

6,297

 

Other adjustments

 

 

 

 

 

 

 

 

 

24

 

Shares Outstanding at June 30, 2006

 

 

$