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, such as those set forth in Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ending December 31, 2008, as amended.

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. that require FDA clearance have been cleared by 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 three and six months ended June 30, 2009 and 2008, 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 June 30, 2009, we licensed or acquired approximately 42 patent and patent applications from third parties. A discussion of our license agreements through December 31, 2008 may be found in "Item 1-Business-Intellectual Property" included in our Annual Report on Form 10-K for the year ending December 31, 2008, as amended.

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 and complementary products, 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 limited 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, depreciation of our surgical instruments, and the amortization of purchased intangibles. We manufacture substantially all of the non-allograft implants that we sell. Our product costs consist primarily of direct labor, manufacturing overhead, raw materials and components. 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 spinal 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, interest expense, gains and losses from foreign currency exchanges and other non-operating gains and losses.

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.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an on-going basis, we evaluate our estimates and assumptions, including those related to revenue recognition, allowances for accounts receivable, inventories, goodwill and intangible assets, stock-based compensation and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions conditions.

Critical accounting policies are those that, in management's view, are most important in the portrayal of our financial condition and results of operations. Management believes there have been no material changes during the three and six months ended June 30, 2009 to the critical accounting policies discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2008, as amended.

Results of Operations

The table below sets forth certain statements of operations data expressed as a
percentage of revenues for the periods indicated. Our historical results are not
necessarily indicative of the operating results that may be expected in the
future.



                                          Three Months Ended June 30,              Six Months Ended June 30,
                                           2009                  2008              2009                 2008
Revenue                                      100.0 %               100.0 %           100.0 %              100.0 %
Cost of revenues                              35.4                  33.6              35.4                 33.8

Gross profit                                  64.6                  66.4              64.6                 66.2
Operating expenses:
Research and development                      10.7                  14.1              10.0                 13.9
In-process research and development           13.9                    -                9.2                  2.8
Sales and marketing                           39.7                  42.2              40.7                 42.9
General and administrative                    17.2                  24.0              18.3                 24.0
Litigation settlement                           -                     -                 -                  23.4

Total operating expenses                      81.5                  80.3              78.2                107.0

Operating loss                               (16.9 )               (13.9 )           (13.6 )              (40.8 )

Other income (expense):
Interest income                                0.1                   0.4               0.1                  0.6
Interest expense                              (2.8 )                (1.1 )            (2.9 )               (1.0 )
Other income (expense), net                    0.5                  (0.2 )            (0.2 )                0.3

Total other income (expense)                  (2.2 )                (0.9 )            (3.0 )               (0.1 )

Loss before taxes                            (19.1 )               (14.8 )           (16.6 )              (40.9 )
Income tax provision                           0.4                   0.3               0.4                  0.3

Net loss                                     (19.5 )%              (15.1 )%          (17.0 )%             (41.2 )%

Reclassification

Certain prior year balances have been reclassified in the accompanying condensed consolidated financial statements to conform to the current year presentation. In our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2008 filed with the SEC on August 6, 2008, our operating expenses in Japan were classified as general and administrative expenses. In this Quarterly Report on Form 10-Q, 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 $1.0 million of general and administrative expense to sales and marketing expense for the three months ended June 30, 2008 and $2.0 million of general and administrative expense to sales and marketing expense for the six months ended June 30, 2008.

Three Months Ended June 30, 2009 Compared to the Three Months Ended June 30, 2008

Revenues. Revenues were $32.3 million for the three months ended June 30, 2009 compared to $23.9 million for the three months ended June 30, 2008, representing an increase of $8.4 million, or 35.3%. U.S. revenues increased $7.0 million, or 36.3%, primarily due to increased sales of our Zodiac, Novel, Trestle, Biologics and Solanas product lines. In addition, Asia revenues increased $1.0 million, or 21.8%, due to both sales volume ($0.6 million) and the favorable affect of foreign currency exchange rates. We commenced sales in Europe in the third quarter of 2008. We recognized revenue of $0.4 million in European sales in the three months ended June 30, 2009.

Cost of revenues. Cost of revenues were $11.4 million for the three months ended June 30, 2009 compared to $8.0 million for the three months ended June 30, 2008, representing an increase of $3.4 million, or 42.4%. The increase was primarily due to $1.5 million in higher product costs associated with increased revenue performance, increased royalty payments of $0.8 million due to increased sales volume and the new royalty payments made in connection with the Biedermann/DePuy litigation settlement, as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as amended, increased depreciation costs of $0.7 million based on a larger installed surgical instruments asset base capitalized during 2009 and higher amortization expenses of $0.4 million due to the absence of an intangible write-off that occurred in the three months ended June 30, 2008.

Gross profit. Gross profit was $20.9 million for the three months ended June 30, 2009 compared to $15.8 million for the three months ended June 30, 2008, representing an increase of $5.1 million, or 31.7%. Gross margin of 64.6% of revenues for the three months ended June 30, 2009 decreased 1.8 percentage points from the three months ended June 30, 2008. The 1.8 percentage point decrease was primarily due to increased royalty payments of 0.9 percentage points, increased instrument depreciation of 1.7 percentage points, an increase of 0.9 percentage points related to amortization of intangibles, partially offset by a decrease of 1.8 percentage points related to improved manufacturing efficiencies.

Research and development. Research and development expenses were $3.4 million for the three months ended June 30, 2009 compared to $3.4 million for the three months ended June 30, 2008, representing substantially no change.

In-process research and development. In-process research and development expenses were $4.5 million for the three months ended June 30, 2009 compared to $0 for the three months ended June 30, 2008. In the three months ended June 30, 2009, we incurred expenses of $3.6 million related to a milestone achieved in connection with successfully meeting a development milestone involving an expandable pedicle screw ($1.8 million in stock and $1.8 million in cash) and $0.9 million in non-cash costs related to our acquisition of technology related to a stand-alone anterior lumbar interbody fusion device.

Sales and marketing. Sales and marketing expenses were $12.8 million for the three months ended June 30, 2009 compared to $10.1 million for the three months ended June 30, 2008, representing an increase of $2.7 million, or 27.3%. The increase was primarily due to higher commission expense of $1.9 million due to the higher U.S. sales volume and an increase of $0.8 million primarily in Asia as we increase our product mix towards Alphatec's spinal products.

General and administrative. General and administrative expenses were $5.6 million for the three months ended June 30, 2009 compared to $5.7 million for the three months ended June 30, 2008, representing a decrease of $0.1 million, or 3.1%. The decrease was primarily related to the reduction of $0.5 million in payroll taxes relating to the expiration of the statute of limitations for a tax contingency reserve established in 2005, less spending in finance and accounting of $0.2 million, offset by increased legal expenses of $0.6 million.

Interest Income. Interest income was $0 for the three months ended June 30, 2009 compared to $0.1 million for the three months ended June 30, 2008, representing a decrease of $0.1 million. The decrease was primarily due to lower cash and cash equivalent balances.

Interest Expense. Interest expense was $0.9 million for the three months ended June 30, 2009 compared to $0.3 million for the three months ended June 30, 2008, representing an increase of $0.6 million. The increase was primarily due to increased interest expense for our loan agreement and line of credit with Silicon Valley Bank and Oxford Finance Corporation. We repaid our line of credit with General Electric Capital Corporation in the fourth quarter of 2008.

Other income (expense), net. Other income (expense), net was $0.2 million for the three months ended June 30, 2009 compared to $0 for the three months ended June 30, 2008, representing an increase in income of $0.2 million. The increase was due to greater foreign currency exchange gains realized in the second quarter of 2009 as compared to the second quarter of 2008.

Income tax provision. Income tax provision was $0.1 million for the three months ended June 30, 2009 compared to $0.1 million for the three months ended June 30, 2008, representing substantially no change. 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 provincial and city income taxes.

Six Months Ended June 30, 2009 Compared to the Six Months Ended June 30, 2008

Revenues. Revenues were $62.9 million for the six months ended June 30, 2009 compared to $47.1 million for the six months ended June 30, 2008, representing an increase of $15.8 million, or 33.6%. U.S. revenues increased $12.2 million, or 32.1%, primarily due to increased sales of our Zodiac, Novel, Trestle, Biologics and Solanas product lines, partially offset by a decrease in our Reveal product line. In addition, Asia revenues increased $2.3 million, or 25.0%, due to both sales volumes ($1.3 million) and the favorable affect of foreign currency exchange rates. We commenced sales in Europe in the third quarter of 2008. We recognized revenue of $1.4 million in European sales in the six months ended June 30, 2009.

Cost of revenues. Cost of revenues were $22.2 million for the six months ended June 30, 2009 compared to $15.9 million for the six months ended June 30, 2008, representing an increase of $6.3 million, or 39.9%. The increase was primarily due to $2.8 million in higher product costs associated with increased revenue performance, increased royalty payments of $1.8 million due to increased sales volume and the new royalty payments made in connection with the Biedermann/DePuy litigation settlement, as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as amended, increased depreciation costs of $1.4 million based on a larger installed surgical instruments asset base capitalized during 2009 and higher amortization expenses of $0.3 million due primarily to the absence of an intangible write-off that occurred in the three months ended June 30, 2008.

Gross profit. Gross profit was $40.6 million for the six months ended June 30, 2009 compared to $31.1 million for the six months ended June 30, 2008, representing an increase of $9.5 million, or 30.4%. Gross margin of 64.6% of revenues for the six months ended June 30, 2009 decreased 1.6 percentage points from the six months ended June 30, 2008. The 1.6 percentage point decrease was primarily due to increased royalty payments of 1.4 percentage points, increased instrument depreciation of 1.8 percentage points, partially offset by a decrease of 1.6 percentage points related to improved manufacturing efficiencies.

Research and development. Research and development expenses were $6.3 million for the six months ended June 30, 2009 compared to $6.6 million for the six months ended June 30, 2008, representing a decrease of $0.3 million, or 3.9%. The decrease was primarily due to decreases in outsourced prototype and other development activities.

In-process research and development. In-process research and development expenses were $5.8 million for the six months ended June 30, 2009 compared to $1.3 million for the six months ended June 30, 2008, representing an increase of $4.5 million. In the six months ended June 30, 2009, we incurred expenses of $3.6 million related to a development milestone that was achieved in connection with our intellectual property involving an expandable pedicle screw ($1.8 million in stock and $1.8 million in cash), $0.9 million in non-cash costs related to our acquisition of technology related to a stand-alone anterior lumbar interbody fusion device, $0.5 million related to our acquisition of technology related to a stand-alone interbody device, $0.6 million related to our acquisition of technology related to a device for the treatment of spinal stenosis ($0.25 million in cash and $0.35 million in stock (174,129 shares)), and $0.3 million combined for six in-process research and development collaborations with third parties. In the six months ended June 30, 2008, we incurred costs for the licenses for the technology related to the expandable VBR license of $1.0 million and a dynamic cervical plate of $0.3 million.

Sales and marketing. Sales and marketing expenses were $25.6 million for the six months ended June 30, 2009 compared to $20.2 million for the six months ended June 30, 2008, representing an increase of $5.4 million, or 26.9%. The increase was primarily due to higher commission expense of $3.7 million due to the higher U.S. sales volume and an increase of $1.7 million primarily in Asia as we increase our product mix towards Alphatec's spinal products.

General and administrative. General and administrative expenses were $11.5 million for the six months ended June 30, 2009 compared to $11.3 million for the six months ended June 30, 2008, representing an increase of $0.2 million, or 2.0%. The increase was primarily due to an increase in legal fees, as well as legal fees and expenses related to the prosecution of our patent portfolio.

Litigation Settlement. Litigation settlement was $11.0 million for the six months ended June 30, 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 during the six months ended June 30, 2009.

Interest Income. Interest income was $0.1 million for the six months ended June 30, 2009 compared to $0.3 million for the six months ended June 30, 2008, representing a decrease of $0.2 million. The decrease was primarily due to lower cash and cash equivalent balances.

Interest Expense. Interest expense was $1.8 million for the six months ended June 30, 2009 compared to $0.4 million for the six months ended June 30, 2008, representing an increase of $1.4 million. The increase was primarily due to increased interest expense for our loan agreement and line of credit with Silicon Valley Bank and Oxford Finance Corporation. We repaid our line of credit with General Electric Capital Corporation in the fourth quarter of 2008.

Other income (expense), net. Other income (expense), net was ($0.1) million for the six months ended June 30, 2009 compared to $0.1 million for the six months ended June 30, 2008, representing a decrease in income of $0.2 million. The decrease was due to greater foreign currency exchange losses realized in 2009 as compared to 2008.

Income tax provision. Income tax provision was $0.2 million for the six months ended June 30, 2009 compared to $0.2 million for the six months ended June 30, 2008, representing substantially no change. 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 provincial and city income taxes.

Liquidity and Capital Resources

At June 30, 2009, our principal sources of liquidity consisted of cash and cash equivalents of $19.7 million, accounts receivable, net of $23.8 million, and remaining amounts available under our credit facility of $0.4 million. We believe such amounts will be sufficient to fund our projected operating requirements through at least June 30, 2010.

Historically, our principal sources of cash have included customer payments from the sale of our products, proceeds from the issuance of common and preferred stock and proceeds from the issuance of debt. Our principal uses of cash have included cash used in operations, acquisitions of businesses and intellectual property rights, payments relating to purchases of property and equipment and repayments of borrowings. We expect that our principal uses of cash in the future will be for operations, working capital, capital expenditures, and potential acquisitions. We expect that, as our revenues grow, our sales and marketing and research and development expenses will continue to grow and, as a result, we will need to generate significant net revenues to achieve profitability. We believe that our current cash and cash equivalents, revenues from our operations, and our ability to draw down on secured credit facilities will be sufficient to fund our projected operating requirements including potential R&D license milestone obligations through at least July 1, 2010. In June 2009, we entered into a subscription agreement with one of our existing shareholders, Healthpoint Capital Partners II, LP. We sold 3,937,007 shares of our common stock at a price of $2.54 per share in a private placement for an aggregate purchase price of approximately $10.0 million. We paid approximately $0.1 million for transaction fees and received aggregate net proceeds of approximately $9.9 million. We intend to use the net proceeds of the placement for general working capital purposes. If we believe it is in our interest to raise additional funds, we may seek to sell additional equity or debt securities or borrow additional money. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are . . .