Our management's discussion and analysis of our financial condition and results of operations 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, manufacturing and marketing of products for the surgical treatment of spine disorders, with a focus on products that treat conditions that affect the aging spine. Our broad product portfolio and pipeline includes a variety of spinal disorder products and systems focused on solutions addressing the cervical, thoracolumbar, intervertebral, minimally invasive, vertebral compression fracture, osteoporotic bone, and spinal stenosis markets. Our principal product offerings are focused on the market for orthopedic spinal disorder solution products, which is estimated in the U.S. to be approximately $5.8 billion in revenue in 2008 and is expected to grow more than 10% annually over the next three years. Our "surgeons' culture" emphasizes collaboration with spinal surgeons to conceptualize, design and co-develop a broad range of products. We have a state-of-the-art, in-house manufacturing facility that provides us with a unique competitive advantage, and enables us to rapidly deliver solutions to meet surgeons' and patients' critical needs. Our products and systems are made of titanium, titanium alloy, stainless steel and a strong, heat resistant, radiolucent, biocompatible plastic called polyetheretherketone, or PEEK. We also sell products made of allograft, a precision-milled and processed human bone that surgeons can use in place of metal and synthetic materials. We also sell bone-grafting products that are comprised of both tissue-based and synthetic materials. We believe that our products and systems have enhanced features and benefits that make them attractive to surgeons and that our broad portfolio of products and systems provide a comprehensive solution for the safe and successful surgical treatment of spine disorders. All of our implants that are sold in the U.S. have been cleared by the U.S. Food and Drug Administration, or the FDA, and these products have been used in over 10,700 and 8,600 spine disorder surgeries in 2008 and 2007, respectively. In addition to selling our products in the U.S., we also sell our products in Japan, the European Union and Hong Kong.

Although our products generally are purchased by hospitals and surgical centers, orders are typically placed at the request of surgeons who then use our products in a surgical procedure. During the twelve months ended December 31, 2008 and December 31, 2007, no single surgeon, hospital or surgical center represented greater than 10% of our consolidated revenues. Additionally, we sell a broad array of products, which diminishes our reliance on any single product or spine disorder.

In 2007, as part of our strategy to focus on disorders affecting the aging spine, we began entering into license agreements with third parties that we believe will enable us to rapidly develop and commercialize unique products for the treatment of spinal disorders that disproportionately affect the aging population. Through December 31, 2008, we licensed approximately 40 patent and patent applications from third parties. A discussion of our license agreements may be found in "Item 1-Business-Intellectual Property" included elsewhere in this Annual Report on Form 10-K.

To assist us in evaluating our product development strategy, we regularly monitor long-term technology trends in the spinal implant industry. Additionally, we consider the information obtained from discussions with the surgeon community and our Scientific Advisory Board in connection with the demand for our products, including potential new product launches. We also use this information to help determine our competitive position in the spinal implant industry and the capacity requirements of our manufacturing facility.

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 spine screw systems, vertebral body replacement devices, plates and bone grafting materials. Our revenues are generated by our direct sales force and independent distributors. Our products are ordered directly by surgeons and shipped and billed to hospitals or surgical centers. In Japan, where orthopedic trauma surgeons also perform spine surgeries, we have sold and will continue to sell orthopedic trauma products in order to introduce our spine products to Japanese surgeons. In Europe, we use independent distributors that purchase our products and market them to their surgeon customers. As a result of offering payment terms greater than our customary U.S. business terms and operating in a new market in which we have no prior experience, revenues for sales to our European distributors have been deferred until payments become due or cash is received.

Cost of revenues. Cost of revenues consists of direct product costs, royalties, and the amortization of purchased intangibles. We manufacture substantially all of the products that we sell. Our product costs consist primarily of direct labor, manufacturing overhead, raw materials and components, and depreciation of our surgical instruments. Allograft product costs include the cost of procurement and processing of human tissue. We incur royalties related to technology we license from others and products developed in part by surgeons with whom we collaborate in the product development. 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 costs also include salaries and related employee benefits, research-related overhead expenses, fees paid to external service providers, and costs associated with our Scientific Advisory Board and executive Surgeon Panels.

In-process research and development. In-process research and development, or IPR&D, consists of acquired research and development assets that were not technologically feasible on the date we acquired worldwide licenses for technology related to the dynamic cervical plate and the expandable interbody products and had no alternative future use at that date. At the time of acquisition, we expect all acquired IPR&D will reach technological feasibility, but there can be no assurance that commercial viability of a product will be achieved. The nature of the efforts to develop the acquired technologies into commercially viable products consists principally of planning, designing, and obtaining regulatory clearances. The risks associated with achieving commercialization include, but are not limited to, delays or failures during the development process, delays or failures to obtain regulatory clearances, and intellectual property rights of third parties.

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 and legal costs.

Litigation settlement. Litigation settlement expense consists of material settlements of lawsuits.

Total other income (expense). Total other income (expense) includes interest income and interest expense.

Income tax provision. Income tax expense consists primarily of state and foreign income taxes and the tax effect of changes in deferred tax liabilities associated with tax goodwill.

Accretion to redemption value of redeemable convertible preferred stock, Rolling common and Series C common stock. Accretion to redemption value of redeemable convertible preferred stock, Rolling common and Series C common stock consists of the increase in carrying value of the redeemable convertible preferred,

Rolling common and Series C common stock as a result of the periodic accretion to the estimated redemption value as of the earliest redemption date. All of redeemable convertible preferred stock, Rolling common and Series C common stock were converted into a combination common stock and redeemable preferred stock at the closing of our initial public offering on June 2, 2006.

Results of Operations

The table below sets forth certain statements of operations data expressed as a percentage of revenues for the periods indicated. Statements of operations data in the table below for the period from March 18, 2005 to December 31, 2005 include the results of the Cortek business since its acquisition on September 9, 2005. Successor refers to Alphatec Holdings. Predecessor refers to Alphatec Spine prior to its acquisition by Alphatec Holdings on March 18, 2005. Combined refers to the combined results of Predecessor and Alphatec Holdings. Our historical results are not necessarily indicative of the operating results that may be expected in the future.

                              Successor             Successor             Successor              Combined            Successor (1)          Predecessor (1)          Predecessor (1)
                                                                                                                       March 18,              January 1,
                              Year Ended            Year Ended            Year Ended            Year Ended              2005 to                 2005 to                Year Ended
                             December 31,          December 31,          December 31,          December 31,          December 31,              March 17,              December 31,
                                 2008                  2007                  2006                  2005                  2005                    2005                     2004
Revenues                            100.0 %               100.0 %               100.0 %               100.0 %                100.0 %                  100.0 %                  100.0 %
Cost of revenues                     36.1                  37.3                  34.7                  41.9                   44.2                     27.8                     30.6

Gross profit                         63.9                  62.7                  65.3                  58.1                   55.8                     72.2                     69.4
Operating expenses:
Research and
development                          12.8                   7.9                   4.8                   2.3                    2.1                      3.6                      6.6
In-process research
and development                       2.7                  11.7                    -                    7.3                    8.5                       -                        -
Sales and marketing                  41.9                  41.9                  48.7                  45.6                   44.7                     51.1                     30.2
General and
administrative                       23.1                  25.8                  41.6                  38.5                   38.9                     35.3                     31.5
Litigation settlement                10.8                    -                     -                     -                      -                        -                        -

Total operating
expenses                             91.3                  87.3                  95.1                  93.7                   94.2                     90.0                     68.3

Operating income
(loss)                              (27.4 )               (24.6 )               (29.8 )               (35.6 )                (38.4 )                  (17.8 )                    1.1

Other income
(expense):
Interest income                       0.4                   1.0                   0.9                   0.3                    0.4                       -                        -
Interest expense                     (1.9 )                (1.1 )                (2.9 )                (4.9 )                 (5.4 )                   (1.9 )                   (1.8 )
Failed acquisition
costs                                  -                     -                   (2.6 )                  -                      -                        -                        -
Other income
(expense), net                        0.5                   0.2                  (0.1 )                (0.3 )                 (0.3 )                    0.1                      4.1

Total other income
(expense)                             1.0                   0.1                  (4.7 )                (4.9 )                 (5.3 )                   (1.8 )                    2.3

Income (loss) before
taxes                               (28.4 )               (24.5 )               (34.5 )               (40.5 )                (43.7 )                  (19.6 )                    3.4
Income tax (benefit)
provision                             0.5                   0.7                   0.4                  (7.2 )                 (8.4 )                     -                       0.5

Net income (loss)                   (28.9 )               (25.2 )               (34.9 )               (33.3 )                (35.3 )                  (19.6 )                    2.9
Accretion to
redemption value of
redeemable convertible
preferred stock,
Rolling common and
Series C common stock                  -                     -                   (4.7 )               (18.0 )                (21.0 )                     -                        -

Net income (loss)
available to common
stockholders                        (28.9 )%              (25.2 )%              (39.6 )%              (51.3 )%               (56.3 )%                 (19.6 )%                   2.9 %

Note:

(1) See Note to the Selected Financial Data table included elsewhere in this Annual Report on Form 10-K for a description of the Successor and Predecessor.

Reclassification

Certain prior year balances have been reclassified in the accompanying consolidated financial statements to conform to the current year presentation. In our SEC filings for the year ended December 31, 2007 and prior years, our operating expenses in Japan were classified as general and administrative expenses. In this Annual Report on Form 10-K, we separated the Japanese sales and marketing expenses from the general and administrative expenses. This reclassification has no impact upon total operating expenses and net loss, and resulted in a reclassification of $3.6 million and $2.9 million of general and administrative expense to sales and marketing expense for the years ended December 31, 2007 and 2006, respectively.

Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007

Revenues. Revenues were $101.3 million for the year ended December 31, 2008 compared to $80.0 million for the year ended December 31, 2007, representing an increase of $21.3 million, or 26.6%. U.S. revenues increased $14.7 million primarily due to increased sales of our Zodiac, Novel, Trestle, and Solanas product lines, partially offset by a decrease in our Reveal product line. In addition, Asia revenues increased $4.4 million primarily due to the increase in sales of spinal products and a full year of revenue from Japan Ortho Medical which was acquired in May 2007. Commencing in the fourth quarter of 2008, we recognized revenue of $2.1 million due to initial European sales.

Cost of revenues. Cost of revenues were $36.6 million for the year ended December 31, 2008 compared to $29.8 million for the year ended December 31, 2007, representing an increase of $6.8 million, or 22.7%. The increase was primarily due to $3.3 million in higher product costs associated with increased revenue performance, an increase of $2.8 million related to the increased revenues that occurred after our acquisition of Japan Ortho Medical in May 2007, higher excess and obsolete provisions of $1.6 million due to increases in inventory, and increased royalty payments of $3.8 million due to increased revenues and the new royalty payments made in connection with the Biedermann and Depuy litigation settlement. The cost increases were partially offset by favorable production variances and improved manufacturing efficiencies of $3.7 million and a $1.2 million decrease in instrument depreciation due to the change in useful life from two to four years. Had the previous useful lives been used, such amortization would have increased by $2.9 million.

Gross profit. Gross profit was $64.7 million for the year ended December 31, 2008 compared to $50.2 million for the year ended December 31, 2007, representing an increase of $14.5 million, or 28.9%. Gross profit of 63.9% of revenues in fiscal year 2008 increased 1.2 percentage points from 2007. The 1.2 percentage point increase was primarily due to favorable production variances and improved manufacturing efficiencies of 3.2 percentage points and less instrument depreciation of 2.2 percentage points due to the change in useful life from two to four years. The increase was partially offset by higher excess and obsolete provisions of 1.5 percentage points and increased royalty payments of 2.8 percentage points.

Research and development. Research and development expenses were $13.0 million for the year ended December 31, 2008 compared to $6.4 million for the year ended December 31, 2007, representing an increase of $6.6 million, or 103.9%. The increase was primarily due to increases in compensation expenses of $1.1 million due to increased headcount, an increase in project materials and prototype expenses of $2.0 million to support new product development, an increase in professional services and consulting expenses of $0.8 million, an increase in rent expense, utilities and other facilities related expenses of $1.4 million, an increase in stock-based compensation expense of $0.4 million, and increases in other expenses to support research and development activities of $0.9 million.

In-process research and development. In-process research and development expenses were $2.8 million for the year ended December 31, 2008 compared to $9.3 million for the year ended December 31, 2007, representing

a decrease of $6.5 million, or 70.6%. The decrease was primarily related to lower licensing costs in 2008 as compared to 2007. In 2008, we incurred in-licensing costs for the technology related to the expandable interbody license of $1.0 million, the OsseoFix license of $1.0 million, the dynamic cervical plate license of $0.3 million and costs related to the neuromonitoring development agreement of $0.3 million. Pursuant to the expandable interbody license agreement, we issued 101,944 shares ($0.5 million) of our common stock and paid $0.5 million in cash to the licensor. Pursuant to the OsseoFix license, we paid $1.0 million in cash to the licensor in connection with the achievement of the design freeze milestone. Pursuant to the dynamic cervical plate license agreement, we issued 25,815 shares ($0.2 million) of our common stock and paid $0.2 million in cash to the licensor. In 2007, we had significant acquisition costs of exclusive licenses for the technology related to the GLIF of $2.3 million, OsseoFix of $5.0 million and OsseoScrew of $2.0 million.

Sales and marketing. Sales and marketing expenses were $42.4 million for the year ended December 31, 2008 compared to $33.5 million for the year ended December 31, 2007, representing an increase of $8.9 million, or 26.5%. The increase was due to higher commission expense of $4.3 million due to the higher sales volume, an increase of $0.7 million in Asia as we shift our product mix towards spinal products, and increases in professional services and consulting expenses of $0.6 million, stock-based compensation expense of $0.5 million, travel costs of $0.5 million, $0.4 million in bad debt expense and increased facility costs and other marketing related expenses of $1.1 million.

General and administrative. General and administrative expenses were $23.4 million for the year ended December 31, 2008 compared to $20.6 million for the year ended December 31, 2007, representing an increase of $2.8 million, or 13.2%. The increase was primarily due an increase of $2.1 million in Asia related to increased professional fees for accounting, Sarbanes-Oxley and consulting services as well as a full year of expenses included in 2008 from the acquisition of Japan Ortho Medical in May 2007. In addition, there was an increase in stock-based compensation expense of $1.6 million as we lowered our forfeiture rate in 2008. In 2007, we had a reduction of stock compensation expense due to a settlement agreement related to certain executives that was reached in June 2007 and an adjustment to the estimated forfeiture rate which resulted in lower expense in 2007. The increases in 2008 were partially offset by a reduction in legal fees and settlement expenses of $0.9 million.

Litigation Settlement. Litigation settlement was $11.0 million for the year ended December 31, 2008. The expense was due to a settlement agreement we entered into in May 2008 with Biedermann and DePuy and the corresponding one-time settlement payment. This one-time settlement payment was paid in May 2008. There was no corresponding litigation settlement expense in 2007.

Interest Income. Interest income was $0.4 million for the year ended December 31, 2008 compared to $0.8 million for the year ended December 31, 2007, representing a decrease of $0.4 million, or 52.8%. The decrease was primarily due to lower cash and cash equivalent balances as a result of the cash used in operating activities as well as the payment of the Biedermann and Depuy litigation settlement.

Interest Expense. Interest expense was $1.9 million for the year ended December 31, 2008 compared to $0.9 million for the year ended December 31, 2007, representing an increase of $1.0 million, or 116.0%. The increase was primarily due to $0.4 million in fees associated with the repayment of our line of credit with General Electric Capital Corporation, or GECC, and equipment notes and the write-off of the remaining debt discount associated with the equipment notes of $0.2 million.

Other income (expense), net. Other income (expense), net was $0.5 million for the year ended December 31, 2008 compared to $0.1 million for the year ended December 31, 2007, representing an increase of $0.4 million or 226.8%. The increase was due to greater foreign currency exchange gains realized in 2008 as compared to 2007.

Income tax provision. Income tax provision was $0.5 million for the year ended December 31, 2008 compared to $0.6 million for the year ended December 31, 2007, representing a decrease of $0.1 million, or 20.7%. We recorded income tax expense of $0.5 million for 2008 which consisted of U.S. income taxes of $0.3

million and foreign income taxes of $0.2 million. The U.S. income tax expense consists primarily of state income taxes and the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill. The foreign income tax expense consists primarily of Japanese prefecture and city income taxes.

Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006

Revenues. Revenues were $80.0 million for the year ended December 31, 2007 compared to $74.0 million for the year ended December 31, 2006, representing an increase of $6.0 million, or 8.1%. U.S. revenues increased $6.1 million primarily due to increased sales of our Zodiac, Novel, Trestle, and Solanas product lines. Asia revenues decreased $0.1 million from fiscal year ended 2006 primarily due to the planned reduction of non-spine revenue of $4.2 million, partially offset by the Japan Ortho Medical acquisition in May 2007 of $3.2 million, increased spine revenue of $0.8 million, and increased revenues in Hong Kong of $0.1 million.

Cost of revenues. Cost of revenues were $29.8 million for the year ended December 31, 2007 compared to $25.7 million for the year ended December 31, 2006, representing an increase of $4.1 million, or 16.0%. The increase in cost of revenues was due to unfavorable production variances, inventory write-offs and scrap of $1.7 million, increased sales volume of $1.6 million, additional instrument depreciation due to higher capital levels of surgical instrument sets of $1.5 million, higher royalties due to product mix of $0.5 million, and higher amortization of intangibles due the Scient'x license agreements of $0.3 million. These cost increases were partially offset by lower excess and obsolete inventory provisions of $1.5 million.

Gross profit. Gross profit was $50.2 million for the year ended December 31, 2007 compared to $48.3 million for the year ended December 31, 2006, representing an increase of $1.9 million, or 3.9%. Gross profit of 62.7% of revenues in fiscal year ended 2007 decreased 2.6 percentage points from 2006. The 2.6 percentage point decrease was primarily due to unfavorable production variances, inventory write-offs and scrap of 1.9 percentage points, higher instrument depreciation of 1.6 percentage points, lower product margins of 0.9 percentage points, and higher royalty expenses of 0.3 percentage points, partially offset by lower excess and obsolescence inventory charges of 2.1 percentage points.

Research and development. Research and development expenses were $6.4 million for the year ended December 31, 2007 compared to $3.6 million for the year ended December 31, 2006, representing an increase of $2.8 million, or 77.2%. The expense increases were primarily due to increases in compensation expenses of $1.4 million due to increased headcount, an increase in consulting expenses of $0.7 million to support the new product introductions, and an increase in lab supplies, project materials and equipment expenses of $0.7 million to support new development.

In-process research and development. In-process research and development expenses were $9.3 million for the year ended December 31, 2007 compared to $0 for the year ended December 31, 2006. This increase was due to in-licensing costs for the technology related to the GLIF of $2.3 million, OsseoFix of $5.0 million and OsseoScrew of $2.0 million. Pursuant to the GLIF license agreement, we issued 750,000 shares ($2.3 million) of our common stock to the licensor. A portion of the common stock is subject to a five-year lockup period, with automatic waivers to occur upon the achievement of certain milestone events. Since these products are still in development, the cash and stock payments were expensed for $9.3 million.

Sales and marketing. Sales and marketing expenses were $33.5 million for the year ended December 31, 2007 compared to $36.0 million for the year ended December 31, 2006, representing a decrease of $2.5 million, or 6.9%. The decrease was due to lower compensation expenses of $1.1 million, lower stock-based compensation expense of $1.1 million, a reduction of consulting and professional service expenses of $0.4 million, lower expenses related to travel and meetings of $0.7 million, a reduction in bad debt expense of $0.4 million, recruiting expense of $0.3 million and severance expenses of $0.4 million. These costs reductions were partially offset by higher commission expense due to the . . .