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. We have a comprehensive product portfolio and pipeline that addresses the cervical, thoracolumbar and intervertebral regions of the spine and covers a variety of major spinal disorders and surgical procedures. Our principal product offerings are focused on the global market for orthopedic spinal disorder solutions. Our "surgeons' culture" enables us to respond to the changing needs of surgeons through 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 the critical needs of surgeons' and patients'. 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 spinal disorders.

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 screws and complementary products, vertebral body replacement devices, plates, products to treat vertebral compression fractures and bone grafting materials. Our revenues are generated by our direct sales force and independent distributors. Our products are requested directly by surgeons and shipped and billed to hospitals and surgical centers. In general, except for those countries where we have a direct sales force (U.S., Japan, France, Italy, and the United Kingdom), we use independent distributors that purchase our products and market them to surgeons. A majority of our business is conducted with customers within markets in which we have experience and with payment terms that are customary to our business. If we offer payment terms greater than our customary business terms or begin operating in a new market, revenues are deferred until the sooner of when payments become due or cash is received from the related distributors.

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

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

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

that date or IPR&D assets acquired in connection with a business acquisition that are determined to have no alternative future use. At the time of acquisition, we expect all acquired IPR&D will reach technological feasibility in the future, 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 delays or failures due to intellectual property rights of third parties.

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

Transaction-related expense. Transaction-related expense consists of legal, accounting and financial advisory fees associated with acquisitions.

Restructuring expense.Restructuring expense consists of severance and other personnel costs related to the reorganization of our management and those costs associated with exit or disposal activities related to the acquisition of Scient'x.

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 benefit. Income tax (benefit) provision consists primarily of income tax benefits related to the French income tax settlement and acquired Scient'x operations offset by state income taxes and the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill.

Results of Operations

The first table below sets forth our statements of operations data for the periods presented. Statements of operations data for the year ended December 31, 2010 do not include the results of Scient'x for the first quarter 2010 as the acquisition closed on March 26, 2010. Our historical results are not necessarily indicative of the operating results that may be expected in the future.

                                                              Year Ended December 31,
                                                       2012            2011            2010
                                                                  (in thousands)
Revenues                                             $ 196,278       $ 197,711       $ 171,610
Cost of revenues                                        70,761          79,168          57,657
Amortization of acquired intangible assets               1,749           1,613           1,136

Gross profit                                           123,768         116,930         112,817
Operating expenses:
Research and development                                14,886          16,888          16,431
In-process research and development                        341              -            2,967
Sales and marketing                                     75,177          75,189          66,542
General and administrative                              39,939          36,367          31,078
Amortization of acquired intangible assets               2,180           2,152           1,535
Transaction related expenses                             1,082              -            3,671
Restructuring expenses                                      -            1,050           2,382
Litigation settlement                                       -            9,800              -

Total operating expenses                               133,605         141,446         124,606

Operating loss                                          (9,837 )       (24,516 )       (11,789 )
Other income (expense):
Interest income                                            118             148              81
Interest expense                                        (6,105 )        (3,027 )        (5,946 )
Other income (expense), net                               (794 )           707           1,167

Total other income (expense)                            (6,781 )        (2,172 )        (4,698 )

Loss from continuing operations before taxes           (16,618 )       (26,688 )       (16,487 )
Income tax benefit                                      (1,159 )        (4,507 )        (2,054 )

Loss from continuing operations                        (15,459 )       (22,181 )       (14,433 )
Income from discontinued operations, net of tax             -               -               78

Net loss                                             $ (15,459 )     $ (22,181 )     $ (14,355 )

Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011

Revenues. Revenues were $196.3 million for the year ended December 31, 2012 compared to $197.7 million for the year ended December 31, 2011, representing a decrease of $1.4 million, or 0.7%. The decrease was a result of an increase in the International regions of $1.9 million, offset by a decrease in the U.S. of $3.3 million.

U.S. revenues were $130.5 million for the year ended December 31, 2012 compared to $133.8 million for the year ended December 31, 2011, representing a decrease of $3.3 million, or 2.5%. The decrease was due to a decrease in the sales of Alphatec instruments and implants ($6.6 million) and a decrease in the sales of Scient'x products ($2.8 million), offset by an increase in sales of Biologics ($4.8 million) and the acquisition of Phygen ($1.3 million).

International revenues were $65.8 million for the year ended December 31, 2012 compared to $63.9 million for the year ended December 31, 2011, representing an increase of $1.9 million, or 3.0%. The growth was due to increased sales of Alphatec products ($7.8 million), offset by a decrease in Scient'x products ($5.9 million). The

revenue from Alphatec product continues to grow as products in the aging Scient'x product portfolio are substituted with Alphatec products. The increase in revenues is inclusive of $2.6 million in negative exchange rate effect.

Cost of revenues. Cost of revenues was $70.8 million for the year ended December 31, 2012 compared to $79.2 million for the year ended December 31, 2011, representing a decrease of $8.4 million, or 10.6%. The decrease was primarily related to lower product costs as a result of a decrease in sales volume and variation in product mix ($0.6 million), favorable manufacturing and absorption variances ($6.5 million), a reduction to inventory adjustments ($5.2 million), a reduction in instrument depreciation expense ($0.5 million), a reduction in royalty and milestone expenses due to the cancellation of certain agreements, lower sales volumes and an adjustment to accruals ($2.3 million), and a decrease in inventory step-up expense related primarily to the Scient'x acquisition ($0.6 million), offset by an increase in the reserve for excess and obsolete inventory ($3.1 million) and the amortization expenses associated with the settlement agreement we entered into in December 2011 with Biomet related to royalties on the sales of our polyaxial screws ($4.2 million).

Amortization of acquired intangible assets. Amortization of acquired intangible assets was $1.8 million for the years ended December 31, 2012 compared to $1.6 million for the year ended December 31, 2011, representing an increase of $0.2 million, or 8.4%. The increase primarily relates to amortization of intangible assets acquired in the Phygen acquisition.

Gross profit. Gross profit was $123.8 million for the year ended December 31, 2012 compared to $116.9 million for the year ended December 31, 2011, representing an increase of $6.9 million, or 5.8%. The increase is due to a change in cost of revenues ($7.9 million), offset by amortization of acquired intangibles ($0.2 million) and decrease in sales volume and variation in product mix ($0.8 million).

Gross margin. Gross margin was 63.1% for the year ended December 31, 2012 compared to 59.1% for the year ended December 31, 2011. The increase of 3.9 percentage points was the result of a reduction in the cost of revenues (3.7 percentage points) and a favorable variation in product mix (0.2 percentage points).

Gross margin for the U.S. region was 68.5% for the year ended December 31, 2012 compared to 65.1% for the year ended December 31, 2011. The increase of 3.4 percentage points was the result of reduced cost of revenues ($7.5 million), offset by a negative variation in revenue volume and product mix ($5.3 million).

Gross margin for the International region was 52.3% for the year ended December 31, 2012 compared to 46.7% for the year ended December 31, 2011. The increase of 5.6 percentage points was the result of a favorable variation in revenue volume and product mix ($4.5 million).

Research and development expense. Research and development expense was $14.9 million for the year ended December 31, 2012 compared to $16.9 million for the year ended December 31, 2011 representing a decrease of $2.0 million, or 11.9%. The decrease was primarily related to reduced European research and development activities to support the Scient'x products ($1.7 million), reorganized management structure in the U.S. ($0.3 million), and reduced activity due to the variation in the timing of the cycle for development and testing ($0.4 million), offset by increased spending on clinical study and trial activity ($0.4 million).

In-process research and development expense. IPR&D expense was $0.3 million for the year ended December 31, 2012 compared to $0 million for the year ended December 31, 2011. During the fourth quarter of 2012, the Company decided that it would not pursue development of in-process research and development assets that had an indefinite life. The Company expensed $0.3 million as in-process research and development related to the write-off of a portion of the in-process research and development assets acquired in the Scient'x acquisition.

Sales and marketing expense. Sales and marketing expense was $75.2 million for the years ended December 31, 2012 and December 31, 2011. Expenses increased as a results sales growth in Japan ($1.8 million), but were offset by a reduction in commission expense related to a decrease in U.S. revenue ($0.6 million), a reduction in post marketing clinical trial expenses ($0.6 million), and a reduction in meeting expenses ($0.6 million).

General and administrative expense. General and administrative expense was $39.9 million for the year ended December 31, 2012 compared to $36.4 million for the year ended December 31, 2011, representing an increase of $3.5 million, or 9.8%. The increase was primarily related to increased litigation expense ($2.0 million), increased expenses related to executive management and consulting costs ($1.5 million), the operating expenses related to the Phygen acquisition ($1.0 million) and severance costs ($0.7 million), offset by a reduction in sales and use tax accruals ($0.7 million) a reduction in recruiting fees ($0.6 million) and a reduction in information technology related expenses ($0.5 million).

Amortization of acquired intangible assets. Amortization of acquired intangible assets was $2.2 million for the years ended December 31, 2012 and December 31, 2011. This expense represents amortization in the period for intangible assets associated with general business assets obtained in the Scient'x and Phygen acquisitions.

Transaction-related expense. Transaction-related expense was $1.1 million for the year ended December 31, 2012 compared to $0.0 million for the year ended December 31, 2011. The transaction-related expenses were for legal, accounting and financial advisory fees associated with the asset acquisition of Phygen, LLC.

Restructuring expense. Restructuring expense was $0 million for the year ended December 31, 2012 compared to $1.1 million for the year ended December 31, 2011. The restructuring expenses were due to severance and other personnel costs incurred in connection with restructuring activities in the United States and Europe.

Litigation settlement. Litigation settlement expense was $9.8 million for the year ended December 31, 2011. The expense was due to a settlement agreement we entered into in December 2011 with Biomet. The amount expensed in 2011 represents the allocated value of the settlement and past royalties element due from the sale of our polyaxial screws. There was no corresponding litigation settlement expense in 2012.

Interest income. Interest income was $0.1 million for the years ended December 31, 2012 and December 31, 2011. Interest income is earned on cash balances held in accounts invested in money market funds.

Interest expense. Interest expense was $6.1 million for the year ended December 31, 2012 compared to $3.0 million for the year ended December 31, 2011, representing an increase of $3.1 million, or 101.7%. Interest expense consisted primarily of interest related to loan agreements and lines of credit. The expense in 2012 includes loss on extinguishment of debt costs of $2.9 million related to the refinancing of the term note and revolving credit facility with Silicon Valley Bank consisting of $2.3 million of early termination fees and $0.6 million for the write-off of capitalized deferred debt offering costs.

Other income (expense), net. Other income (expense) was an expense of $(0.8) million for the year ended December 31, 2012 compared to income of $0.7 million for the year ended December 31, 2011. The decrease was due to unfavorable foreign currency exchange results realized in 2012 as compared to favorable results in 2011.

Income tax benefit. Income tax was a benefit of $1.2 million for the year ended December 31, 2012 compared to a benefit of $4.5 million for the year ended December 31, 2011, representing a decrease of $3.3 million, or 74.3%. The 2012 benefit for income taxes primarily consists of benefits associated with the Company's French operations and the reversal of the valuation allowance against the Japanese deferred tax assets partially offset by an increase in uncertain tax positions associated with the European operations and an increase in the goodwill deferred tax liability. The 2011 benefit for income taxes consists primarily of income tax benefits related to a French income tax settlement and acquired Scient'x operations, offset by state income taxes and the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill.

Year Ended December 31, 2011 Compared to the Year Ended December 31, 2010

Revenues. Revenues were $197.7 million for the year ended December 31, 2011 compared to $171.6 million for the year ended December 31, 2010, representing growth of $26.1 million, or 15.2%. The increase was comprised of $13.9 million and $12.2 million of sales in the U.S. and International regions, respectively.

U.S. revenues were $133.8 million for the year ended December 31, 2011 compared to $119.9 million for the year ended December 31, 2010, representing an increase of $13.9 million, or 11.6%. The growth was due to increased sales of Alphatec products ($12.5 million) from instruments and implants ($8.3 million) and Biologics ($4.2 million) and sales of Scient'x products ($1.4 million).

International revenues were $63.9 million for the year ended December 31, 2011 compared to $51.7 million for the year ended December 31, 2010, representing an increase of $12.2 million, or 23.5%. The growth was due to increased sales of Alphatec products of $9.9 million and Scient'x products of $4.1 million, offset by $1.8 million for the recognition of deferred revenue in 2010 related to a European sale that was not repeated in 2011. The increase in revenues is inclusive of $4.6 million in favorable exchange rate effect.

Cost of revenues. Cost of revenues was $79.2 million for the year ended December 31, 2011 compared to $57.7 million for the year ended December 31, 2010, representing an increase of $21.5 million, or 37.3%. The increase was primarily related to greater product costs due to growth in sales and variation in product mix ($2.2 million), inventory write-offs resulting from the redesign of a deployment mechanism and the associated instrumentation ($2.1 million), inventory adjustments ($4.5 million), an increase in instrument depreciation costs based on a larger installed base of surgical instruments ($1.7 million), unfavorable purchase price variances ($0.5 million), unfavorable manufacturing and absorption variances related to production volume and operational costs ($6.7 million), offset by royalty and sales milestone accruals due to sales mix and timing of contractual obligations ($1.2 million), and a decrease in amortization expense related to acquired technology ($0.1 million). Our costs for Scient'x products for the year ended December 31, 2011 was $5.1 million higher than such product costs for the year ended December 31, 2010 as we sold Scient'x products for the full year of 2011 as compared to only nine months in 2010.

Amortization of acquired intangible assets. Amortization of acquired intangible assets was $1.6 million for the year ended December 31, 2011 compared to $1.1 million for the year ended December 31, 2010, representing an increase of $0.5 million, or 42.0%. This expense represents amortization in the period for intangible assets associated with product related assets obtained in the Scient'x acquisition.

Gross profit. Gross profit was $116.9 million for the year ended December 31, 2011 compared to $112.8 million for the year ended December 31, 2010, representing an increase of $4.1 million, or 3.6%. The increase is comprised of increased revenues from Scient'x products ($0.5 million) and Alphatec products in the International region ($5.6 million), offset by increased cost of revenues related to Alphatec products ($2.0 million).

Gross margin. Gross margin was 59.1% for the year ended December 31, 2011 compared to 65.7% for the year ended December 31, 2010. The decrease of 6.6% was the result of a decrease in the gross margin of Scient'x products from 44.5% to 38.7% and a decrease in Alphatec products from 69.9% to 63.3%.

Gross margin for the U.S. region was 65.1% for the year ended December 31, 2011 compared to 74.4% for the year ended December 31, 2010. The decrease of 9.4% was the result of a decrease in Scient'x gross margin (19.3 percentage points) and a decrease in Alphatec gross margins (8.9 percentage points), primarily related to inventory write-offs and unfavorable manufacturing and absorption variances.

Gross margin for the International region was 46.7% for the year ended December 31, 2011 compared to 45.6% for the year ended December 31, 2010. The increase of 1.2% was the result of increased gross margin for Alphatec products (3.7 percentage points) offset by decreased gross margin for Scient'x products (3.1 percentage points) primarily related to a variation in product mix and pricing.

Research and development expense. Research and development expense was $16.9 million for the year ended December 31, 2011 compared to $16.4 million for the year ended December 31, 2010, representing an increase of $0.5 million, or 2.8%. The increase was primarily related to increased European research and development activities to support the Scient'x products ($0.9 million), increased testing, consulting and prototypes for new products ($2.0 million), offset by reduced activity due to the variation in the timing of the development cycle for clinical research and trials ($0.5 million) and biologics products ($1.1 million).

In-process research and development expense. IPR&D expense was $0 for the year ended December 31, 2011 compared to $3.0 million for the year ended December 31, 2010. During 2010 we incurred expenses of $2.5 million for the acquisition of technology related to stem cells, $0.4 million for the acquisition of bone-anchoring screw technology and $0.1 million for the acquisition of technology related to an anterior cervical plate system. We did not have any acquisitions of a business during 2011.

Sales and marketing expense. Sales and marketing expense was $75.2 million for the year ended December 31, 2011 compared to $66.5 million for the year ended December 31, 2010, representing an increase of $8.6 million, or 13.0%. The increase was primarily related to expenses related to increased European selling and marketing activities in support of the Scient'x products ($2.3 million), increased expense for our international sales force ($5.3 million), and increased selling and marketing activities in the U.S. to increase sales volume ($1.0 million).

General and administrative expense. General and administrative expense was $36.4 million for the year ended December 31, 2011 compared to $31.1 million for the year ended December 31, 2010, representing an increase of $5.3 million, or 17.0%. The increase was primarily a result of an expanded administrative structure to drive sales growth in both the U.S. and International regions. Specifically, human resources ($1.5 million), finance and accounting ($0.8 million), information technology ($0.5 million), legal ($0.6 million) and increased sales and use tax accruals for periods under audit ($0.7 million). Increased expenses resulting from European general and administrative activities in support of the Scient'x products ($2.1 million) were partially offset by a reduction in international expenses resulting from integration efforts ($0.9 million).

Amortization of acquired intangible assets. Amortization of acquired intangible assets was $2.2 million for the year ended December 31, 2011 compared to $1.5 million for the year ended December 31, 2010, representing an increase of $0.6 million, or 40.2%. This expense represents amortization in the period for intangible assets associated with general business assets obtained in the Scient'x acquisition.

Transaction-related expense. Transaction-related expense was $0 for the year ended December 31, 2011 compared to $3.7 million for the year ended December 31, 2010. The transaction-related expenses were for legal, accounting and financial advisory fees associated with the acquisition of Scient'x.

Restructuring expense. Restructuring expense was $1.1 million for the year ended December 31, 2011 compared to $2.4 million for the year ended December 31, 2010, representing a decrease of $1.3 million, or 55.9%. The restructuring expenses were due to severance and other personnel costs incurred in connection with restructuring activities in the United States and Europe.

Litigation settlement. Litigation settlement expense was $9.8 million for the year ended December 31, 2011. The expense was due to a settlement agreement we entered into in December 2011 with Biomet. The amount expensed in 2011 . . .