You should read the following discussion of our financial condition and results of operations together with the unaudited consolidated financial statements and the notes thereto included elsewhere in this report, and other financial information included in this report. The following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under "Special Note Regarding Forward-Looking Statements" and elsewhere in this report. These risks could cause our actual results to differ materially from any future performance suggested below.

Overview

We are a global medical device company focused on surgeons that treat musculoskeletal injuries and disorders of the shoulder, elbow, wrist, hand, ankle and foot. We refer to these surgeons as extremity specialists. We sell to this extremity specialist customer base a broad line of joint replacement, trauma, sports medicine and biologic products to treat extremity joints. Our motto of "specialists serving specialists" encompasses this focus. In certain international markets, we also offer joint replacement products for the hip and knee. We currently sell over 90 product lines in approximately 35 countries.

We believe we are differentiated by our full portfolio of upper and lower extremity products, our extremity-focused sales organization and our strategic focus on extremities. We further believe that we are well positioned to benefit from the opportunities in the extremity products marketplace as we are among the global leaders in the shoulder and ankle joint replacement markets. We also have expanded our technology base and product offering to include: new joint replacement products based on new designs and materials; improved trauma products based on innovative designs; and proprietary biologic materials for soft tissue repair. In the United States, which is the largest orthopaedic market, we believe that our single, "specialists serving specialists" distribution channel is strategically aligned with what we believe is an ongoing trend in orthopaedics for surgeons to specialize in certain parts of the anatomy or certain types of procedures.

Our principal products are organized in four major categories: upper extremity joints and trauma, lower extremity joints and trauma, sports medicine and biologics, and large joints and other. Our upper extremity joints and trauma products include joint replacement and bone fixation devices for the shoulder, hand, wrist and elbow. Our lower extremity joints and trauma products include joint replacement and bone fixation devices for the foot and ankle. Our sports medicine and biologics product category includes products used across several anatomic sites to repair or regenerate soft tissue. Our large joints and other products include hip and knee joint replacement implants and ancillary products.

In the United States, we sell products from our upper extremity joints and trauma, lower extremity joints and trauma, and sports medicine and biologics product categories; we do not actively market large joints in the United States. While we market our products to extremity specialists, our revenue is generated from sales to healthcare institutions and distributors. We sell through a single sales channel consisting of a network of independent commission-based sales agencies, with occasional variations based upon individual territories. Internationally, in select markets, we sell our full product portfolio, including upper extremity joints and trauma, lower extremity joints and trauma, sports medicine and biologics and large joints. We utilize several distribution approaches depending on the individual market requirements, including direct sales organizations in the largest European markets and Australia, and independent distributors for most other international markets. During second quarter of 2012, we acquired our sole and exclusive distributor in Belgium and Luxembourg enabling us to begin selling our products directly in those markets. The financial terms of the transaction included an upfront cash payment of €2.0 million and potential earn-out payments aggregating up to approximately €0.8 million based on annual revenues of the acquired entity for the two years following the acquisition. Also in the second quarter, we opened a direct sales office in Japan and received additional product registrations in China. For the six months ended July 1, 2012, we generated revenue of $140.5 million, 54% of which was in the United States and 46% of which was international.

We have significantly grown our business during the past several years and have built an extremities focused business that offers a broad range of products to a focused group of specialty surgeons. We believe this strategy has been the primary factor in enabling our revenue growth during such time. During the past several years, we also have increased our operating expenses significantly. We have strategically invested with particular emphasis on product development, acquisition of strategic products and technologies, manufacturing capacity, sales commissions and infrastructure to support both current and anticipated growth.

In April 2012, we announced a facilities consolidation initiative pursuant to which we intend to consolidate a number of our facilities in France, Ireland and the United States. Under the initiative, we intend to consolidate our St. Ismier, France manufacturing facility into our existing Montbonnot, France manufacturing facility; consolidate our Dunmanway, Ireland manufacturing facility into our Macroom, Ireland manufacturing facility; and lease a facility near Minneapolis, Minnesota in which we will consolidate our Minneapolis-based marketing, training, regulatory, clinical, supply chain and corporate functions with our Stafford, Texas-based distribution operations. The facilities consolidation initiative is driven by our strategy to drive operational productivity and to reduce annual operating expenses beginning in 2013. We closed our Dunmanway, Ireland facility in the second quarter of 2012 and we

anticipate that we will close our St. Ismier, France facility during the third quarter of 2012 and our Stafford, Texas location by the end of 2012. In addition, during the second quarter of 2012, we entered into a new lease agreement for a new facility located in Bloomington, Minnesota to use as our U.S. business headquarters and to consolidate our Minneapolis-based functions with our Stafford, Texas distribution operations. We anticipate that, in connection with implementing the facilities consolidation initiative, we will record pre-tax charges of approximately $6.0 to $7.0 million, comprised of one-time employee termination costs; facility closure, moving and related expenses; fixed asset write-offs net of anticipated proceeds from the sale of facilities in Stafford, Texas and Dunmanway, Ireland; and other miscellaneous related charges. We expect to record substantially all of the charges during 2012. We expect approximately $5.0 to $5.7 million of the charges will result in cash expenditures, substantially all of which will be incurred in 2012. We expect to achieve annual pre-tax cost savings in the range of approximately $2.3 to $2.8 million related primarily to manufacturing and distribution efficiencies and reduced related operating expenses beginning in 2013. During the six months ended July 1, 2012, we recorded $2.5 million of expense related to the facilities consolidation initiative.

On July 17, 2012, we appointed Shawn T McCormick as Chief Financial Officer of our company effective as of September 4, 2012. Mr. McCormick will succeed Carmen L. Diersen, our former Global Chief Financial Officer who will remain as a consultant to our company through July 16, 2013. Douglas W. Kohrs, our President and Chief Executive Officer, is serving as our Interim Chief Financial Officer until Mr. McCormick assumes the position on September 4, 2012. During the second quarter of 2012, we incurred a special charge of $0.4 million relating to the severance arrangement with our former Global Chief Financial Officer.

Foreign Currency Exchange Rates

A substantial portion of our business is located outside the United States and as a result we generate revenue and incur expenses denominated in currencies other than the U.S. dollar. The majority of our operations denominated in currencies other than the U.S. dollar are denominated in Euros. In both the six months ended July 1, 2012 and July 3, 2011, approximately 46%, of our revenue was denominated in foreign currencies. As a result, our revenue can be significantly impacted by fluctuations in foreign currency exchange rates. We expect that foreign currencies will continue to represent a similarly significant percentage of our revenue in the future. Selling, marketing and administrative costs related to these sales are largely denominated in the same foreign currencies, thereby limiting our foreign currency transaction risk exposure. In addition, we also have significant levels of other selling, general and administrative expenses and research and development expenses denominated in foreign currencies. We, therefore, believe that the risk of a significant impact on our earnings from foreign currency fluctuations is mitigated to some extent.

A substantial portion of the products we sell in the United States are manufactured in countries where costs are incurred in Euros. Fluctuations in the Euro to U.S. dollar exchange rate will have an impact on the cost of the products we manufacture in those countries, but we would not likely be able to change our U.S. dollar selling prices of those same products in the United States in response to those cost fluctuations. As a result, fluctuations in the Euro to U.S. dollar exchange rates could have a significant impact on our gross profit in future periods in which that inventory is sold. Fluctuations in the value of foreign currencies relative to the U.S. dollar impact our operating results. Impacts associated with fluctuations in foreign currency exchange rates are discussed in more detail under "Item 3 -Quantitative and Qualitative Disclosures about Market Risk." In countries with functional currencies other than the U.S. dollar, assets and liabilities are translated into U.S. dollars using end-of-period exchange rates; and revenues, expenses and cash flows are translated using average rates of exchange. Constant currency growth rates used in the following discussion of results of operations eliminate the impact of period-over-period foreign currency fluctuations.

We evaluate our results of operations on both an as reported and a constant currency basis. The constant currency presentation is a non-GAAP financial measure, which excludes the impact of fluctuations in foreign currency exchange rates. We believe providing constant currency information provides valuable supplemental information regarding our results of operations, consistent with how we evaluate our performance. We calculate constant currency percentages by converting our current-period local currency financial results using the prior-period foreign currency exchange rates and comparing these adjusted amounts to our prior-period reported results. This calculation may differ from similarly-titled measures used by others; and, accordingly, the constant currency presentation is not meant to be a substitution for recorded amounts presented in conformity with GAAP nor should such amounts be considered in isolation.

Results of Operations

The three and six months ended July 1, 2012 and July 3, 2011 each consisted of
13 and 26 weeks, respectively. The following table sets forth, for the periods
indicated, our results of operations as a percentage of revenue:



                                                    Three months ended                                    Six months ended
                                             July 1,                   July 3,                   July 1,                    July 3,
                                              2012                      2011                       2012                       2011
                                                      (in thousands)                                       (in thousands)
Statements of Operations Data:
Revenue                                $ 66,014        100 %     $ 65,158        100 %     $ 140,472        100 %     $ 134,593        100 %
Cost of goods sold                       18,098         27 %       18,017         28 %        39,214         28 %        38,058         28 %

Gross profit                             47,916         73 %       47,141         72 %       101,258         72 %        96,535         71 %
Selling, general and administrative      41,795         63 %       41,234         64 %        85,633         61 %        81,958         61 %
Research and development                  5,446          8 %        5,189          8 %        11,069          8 %        10,299          8 %
Amortization of intangible assets         2,636          4 %        2,897          4 %         5,283          4 %         5,707          4 %
Special charges                           2,910          4 %          132          0 %         2,910          2 %           132          0 %

Operating loss                           (4,871 )       (7 %)      (2,311 )       (4 %)       (3,637 )       (3 )%       (1,561 )       (1 %)
Interest income                             121          0 %          142          0 %           234          0 %           270          0 %
Interest expense                           (462 )       (1 %)        (631 )       (1 %)         (949 )       (1 %)       (3,237 )       (2 %)
Foreign currency transaction gain           106          0 %          226          0 %           131          0 %           147         (0 %)
Loss on extinguishment of debt               -             *           -             *            -             *       (29,475 )      (22 %)
Other non-operating (expense) income         (3 )        0 %           35          0 %            (2 )        0 %            16          0 %

Loss before income taxes                 (5,109 )       (8 %)      (2,539 )       (4 %)       (4,223 )       (3 %)      (33,840 )      (25 %)
Income tax benefit (expense)                 25         (0 %)        (330 )       (1 %)       (1,037 )       (1 %)        7,002          5 %

Consolidated net loss                  $ (5,084 )       (8 %)      (2,869 )       (4 %)       (5,260 )       (4 %)      (26,838 )      (20 %)

* Not meaningful

The following tables set forth, for the periods indicated, our revenue by product category and geography expressed as dollar amounts and the changes in revenue between the specified periods expressed as percentages:

                                           Three months ended                                               Six months ended
                                         July 1,        July 3,        Percent          Percent          July 1,        July 3,        Percent          Percent
Revenue by Product Category                2012           2011          change           change           2012           2011           change           change
                                                                         (as           (constant                                         (as           (constant
                                            ($ in thousands)          reported)        currency)            ($ in thousands)          reported)        currency)
Upper extremity joints and trauma       $   42,987      $ 40,795               5 %              9 %     $  90,005      $  82,950               9 %             11 %
Lower extremity joints and trauma            6,489         6,447               1                3          13,518         13,079               3                5
Sports medicine and biologics                3,745         3,583               5                8           7,876          7,440               6                8

Total extremities                           53,221        50,825               5                8         111,399        103,469               8               10
Large joints and other                      12,793        14,333             (11 )              0          29,073         31,124              (7 )              1

Total                                   $   66,014      $ 65,158               1 %              6 %     $ 140,472      $ 134,593               4 %              8 %

                         Three months ended                                           Six months ended
                        July 1,       July 3,       Percent         Percent         July 1,       July 3,       Percent         Percent
Revenue by Geography      2012          2011         change          change          2012          2011          change          change
                                                      (as          (constant                                      (as          (constant
                          ($ in thousands)         reported)       currency)          ($ in thousands)         reported)       currency)
United States          $   36,569     $ 34,395              6 %             6 %    $  76,270     $  71,416              7 %             7 %
International              29,445       30,763             (4 )             6         64,202        63,177              2               9

Total                  $   66,014     $ 65,158              1 %             6 %    $ 140,472     $ 134,593              4 %             8 %

Comparison of three months ended July 1, 2012 to three months ended July 3, 2011

Revenue. Revenue increased by 1% to $66.0 million for the second quarter of 2012 from $65.2 million for the second quarter of 2011, as a result of increased sales in each of our extremity categories, partially offset by a decrease in sales of large joints and other. Our revenue was negatively impacted by foreign currency exchange rate fluctuations of approximately $3.2 million, principally due to the performance of the U.S. dollar against the Euro. Excluding the impact of foreign currency exchange rate fluctuations, revenue increased by 6% for the second quarter of 2012 from the second quarter of 2011. The most significant increase occurred in our upper extremity joints and trauma category. The growth experienced in the extremity categories was due primarily to increased demand and product expansion. Our overall revenue growth of $0.8 million consisted of 6% growth in the United States, partially offset by a revenue decrease of 4% in our international geographies.

Revenue by product category. Revenue in upper extremity joints and trauma increased by 5% to $43.0 million for the second quarter of 2012 from $40.8 million for the second quarter of 2011, primarily as a result of the continued increase in sales of our Aequalis reversed and Aequalis Ascend shoulder products, and to a lesser degree, our Simpliciti shoulder products. We believe that increased sales of our Aequalis reversed shoulder products resulted from continued market growth in shoulder replacement procedures and continued market movement towards reversed shoulder replacement procedures. We also saw an increase in sales of our Aequalis Ascend shoulder products which continued to gain share in the shoulder replacement market. Offsetting this increase was the negative impact of foreign currency exchange rate fluctuations of $1.4 million. Revenue in our lower extremity joints and trauma increased by 1% to $6.5 million for the second quarter of 2012 from $6.4 million for the second quarter of 2011, primarily due to increased sales in our ankle replacement and ankle fusion products in the United States. Revenue in sports medicine and biologics increased by 5% to $3.7 million for the second quarter of 2012 from $3.6 million for the second quarter of 2011. This increase was attributable to increased sales of our anchor products internationally, partially offset by a decrease in sales of our biologics products. Revenue from large joints and other decreased by 11% to $12.8 million for the second quarter of 2012 from $14.3 million for the second quarter of 2011 related primarily to negative foreign currency exchange rate fluctuations of $1.5 million. Excluding the impact of foreign currency fluctuations, our large joints and other product category remained flat in the second quarter of 2012 compared to the second quarter of 2011.

Revenue by geography. Revenue in the United States increased by 6% to $36.6 million for the second quarter of 2012 from $34.4 million for the second quarter of 2011, primarily driven by the continued increase in sales of upper extremities joints and trauma products, partially offset by the negative impact on sales as a result of certain distribution channel changes made during 2012. International revenue decreased by 4% to $29.4 million for the second quarter of 2012 from $30.8 million for the second quarter of 2011 related primarily to negative foreign currency exchange rate fluctuations of $3.2 million. Excluding the impact of foreign currency exchange rate fluctuations, our international revenue increased by 6%. This increase was primarily due to increased revenue in Germany, Australia and the establishment of a direct sales office in Belgium, which also serves Luxembourg, through the acquisition of our previous exclusive distributor in these territories, partially offset by a negative impact on sales in certain Western European countries due to austerity measures and lower procedure volumes.

Cost of goods sold. Our cost of goods sold increased to $18.1 million for the second quarter of 2012 from $18.0 million for the second quarter of 2011. As a percentage of revenue, cost of goods sold decreased from 28% for the second quarter of 2011 to 27% for the second quarter of 2012, primarily due to a lower level of excess and obsolete inventory charges in the second quarter of 2012 and a change in geographical mix. Our cost of goods sold and corresponding gross profit as a percentage of revenue can be expected to fluctuate in future periods depending upon certain factors, including, among others, changes in our product sales mix and prices, distribution channels and geographies, manufacturing yields, plans for insourcing some previously outsourced production activities, inventory reserves required, levels of production volume and fluctuating inventory costs due to changes in foreign currency exchange rates since the period they were manufactured.

Selling, general and administrative. Our selling, general and administrative expenses increased by 1% to $41.8 million for the second quarter of 2012 from $41.2 million for the second quarter of 2011. As a percentage of revenue, selling, general and administrative expenses were 63% for the six months ended July 1, 2012 compared to 64% for the six months ended July 3, 2011. Our variable selling costs as a percentage of revenue were slightly lower during the second quarter of 2012 when compared to the second quarter of 2011, which was partially offset by an increase in instrument depreciation as a percentage of revenue. The increase in total selling, general and administrative expense was primarily a result of additional instrument depreciation, information technology and legal related costs, partially offset by a decrease in non-variable selling related expenses. Also affecting selling, general and administrative expenses was the favorable impact of foreign currency exchange rate fluctuations of $2.3 million.

Research and development. Research and development expenses increased by 5% to $5.4 million for the second quarter of 2012 from $5.2 million for the second quarter of 2011. As a percentage of revenue, research and development expenses remained consistent with the second quarter of 2011 at 8%. The increase in total research and development expense was primarily due to increased clinical study related expenses, an increased level of expenses on certain shoulder and biologic related product development projects and increased personnel related expenses. These items were partially offset by the favorable impact of foreign currency exchange rate fluctuations of $0.3 million. We believe that continued investment in research and development is an important part of sustaining our growth strategy through new product development and anticipate that in the near future, research and development expenses as a percentage of revenue will remain consistent with past levels.

Amortization of intangible assets. Amortization of intangible assets decreased by 9% to $2.6 million for the second quarter of 2012 from $2.9 million for the second quarter of 2011, primarily as a result of the complete amortization of certain license related intangibles.

Special charges. Special charges included approximately $2.5 million of expense for the three months ended July 1, 2012 related to our facilities consolidation initiative. The $2.5 million is comprised of employee-benefit related expenses including severance and retention of terminated employees in the U.S., moving and transportation expenses, impairment charges on fixed assets related to the impacted facilities of Stafford, Texas, St. Ismier, France, and Dunmanway, Ireland, professional fees and other expenses. See Note 13 to our consolidated financial statements for additional information on the facilities consolidation initiative. Also included in special charges for the three months ended July 1, 2012 is approximately $0.4 million of expense related to departure of our former Global Chief Financial Officer and $0.1 million of legal costs related to the acquisition of our exclusive distributor in Belgium and Luxembourg. For the three months ended July 3, 2011, the $0.1 million of special charges were primarily related to the closure of our Beverly, Massachusetts research and development facility.

Interest income. Our interest income remained consistent at $0.1 million during the second quarter of 2012 and the second quarter of 2011.

Interest expense. Our interest expense decreased by 27% to $0.5 million for the second quarter of 2012 from $0.6 million for the second quarter of 2011 due to lower average interest rates on outstanding debt. Our interest expense for the second quarters of 2012 and 2001 related to the interest paid on our continuing term loans, mortgages and existing lines of credit and overdraft arrangements.

Foreign currency transaction gain. We recognized $0.1 million of foreign currency transaction gain in the second quarter of 2012 compared to a foreign currency transaction gain of $0.2 million for the second quarter of 2011. Foreign currency gains and losses are recognized when a transaction is denominated in a currency other than the subsidiary's functional currency. The decrease in foreign currency transaction gain was primarily attributable to foreign currency exchange rate fluctuations on foreign currency denominated intercompany payables and receivables.

Other non-operating (expense) income. Our other non-operating (expense) income was immaterial during both the second quarter of 2012 and the second quarter of 2011.

Income tax benefit (expense). Our effective tax rate for the second quarter of 2012 and 2011 was 0% and 13%, respectively. The change in our effective tax rate from the second quarter of 2011 to the second quarter of 2012 primarily relates to the relative percentage of our pre-tax income from operations in countries with related income tax expense compared to operations in countries in which we have pre-tax losses but for which we record a valuation allowance against our deferred tax assets, and thus, cannot recognize income tax benefits. We recorded a minimal income tax benefit during the second quarter of 2012 compared to an expense of $0.3 million for the second quarter of 2011. Given our history of . . .