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ATEC > SEC Filings for ATEC > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for ALPHATEC HOLDINGS, INC.


2-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2012, as well as any updates to those risk factors filed from time to time in our Quarterly Reports on Form 10-Q or Current Reports on Form 8-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 (the 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 earlier 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.

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, medical device excise tax 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.

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. The income tax benefit consists primarily of income tax benefits related to operations in Japan and Brazil, partially offset by state income taxes, the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill and operations in the Company's other foreign jurisdictions.

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


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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 assumption 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 months ended March 31, 2013 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, 2012.

Results of Operations

The table below sets forth certain statements of operations data 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
                                                             March 31,
                                                        2013           2012
       Revenues                                       $  50,443      $ 48,461
       Cost of revenues                                  17,270        16,263
       Amortization of acquired intangible assets           431           379

       Gross profit                                      32,742        31,819
       Operating expenses:
       Research and development                           3,682         4,010
       Sales and marketing                               18,495        18,536
       General and administrative                        11,130         8,825
       Amortization of acquired intangible assets           793           574

       Total operating expenses                          34,100        31,945

       Operating loss                                    (1,358 )        (126 )
       Other income (expense):
       Interest income                                        2            39
       Interest expense                                    (695 )        (708 )
       Other expense, net                                  (650 )        (259 )

       Total other expense                               (1,343 )        (928 )

       Loss from continuing operations before taxes      (2,701 )      (1,054 )
       Income tax (benefit) provision                       (52 )         207

       Net loss                                       $  (2,649 )    $ (1,261 )

Three Months Ended March 31, 2013 Compared to the Three Months Ended March 31, 2012

Revenues. Revenues were $50.4 million for the three months ended March 31, 2013 compared to $48.5 million for the three months ended March 31, 2012, representing an increase of $2.0 million, or 4.1%. The increase was comprised of $0.5 million related to sales in the U.S. region and $1.5 million related to sales in the International region.

U.S. revenues were $33.1 million for the three months ended March 31, 2013 compared to $32.6 million for the three months ended March 31, 2012, representing an increase of $0.5 million, or 1.5%. The increase was due to sales resulting from the Phygen acquisition ($2.0 million), partially offset by a decrease in the sales of instruments and implants ($1.5 million).

International revenues were $17.4 million for the three months ended March 31, 2013 compared to $15.9 million for the three months ended March 31, 2012, representing an increase of $1.5 million, or 9.3%. The increase was due to sales of Alphatec implants and instruments. The revenue from Alphatec products continues to grow as products in the aging Scient'x product portfolio are substituted with Alphatec products. The increase in revenue is inclusive of $1.1 million in unfavorable exchange rate effect.

Cost of revenues. Cost of revenues was $17.3 million for the three months ended March 31, 2013 compared to $16.3 million for the three months ended March 31, 2012, representing an increase of $1.0 million, or 6.2%. The increase was primarily related to


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greater product costs as a result of a increase in sales volume and variation in product mix ($2.1 million), an increase in the reserve for excess and obsolete inventory ($0.7 million) partially offset by a reduction to inventory adjustments ($1.0 million), and a reduction in royalty and milestone expenses due to the cancellation of certain agreements, change in product mix and an adjustment to accruals ($0.8 million).

Amortization of acquired intangible assets. Amortization of acquired intangible assets was $0.4 million for each of the three months ended March 31, 2013 and March 31, 2012. 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 $32.7million for the three months ended March 31, 2013 compared to $31.8 million for the three months ended March 31, 2012, representing an increase of $0.9 million, or 2.9%. The increase is due to a reduction in the cost of revenues ($0.9 million) and an increase in sales volume ($1.5 million), offset by a decrease resulting from variation in product mix and pricing ($1.5 million).

Gross margin. Gross margin was 64.9% for the three months ended March 31, 2013 compared to 65.7% for the three months ended March 31, 2012. The decrease of 0.8 percentage points was the result of an unfavorable variation in pricing and product mix (3.1 percentage points), offset by a reduction in the cost of revenues (2.3 percentage points).

Gross margin for the U.S. region was 69.7% for the three months ended March 31, 2013 compared to 70.2% for the three months ended March 31, 2012. The decrease of 0.5 percentage points was the result of an unfavorable variation in pricing and product mix (3.1 percentage points), offset by a reduction in the cost of revenues (2.6 percentage points).

Gross margin for the International region was 55.8% for the three months ended March 31, 2013 compared to 56.4% for the three months ended March 31, 2012. The decrease of 0.6 percentage points was the result of an unfavorable variation in pricing and product mix (2.4 percentage points), offset by a reduction in the cost of revenues (1.8 percentage points).

Research and development expense. Research and development expense was $3.7 million for the three months ended March 31, 2013 compared to $4.0 million for the three months ended March 31, 2012, representing a decrease of $0.3 million, or 8.2%. The decrease was primarily related to the variations in the timing of the cycle for development and testing.

Sales and marketing expense. Sales and marketing expense was $18.5 million for each of the three months ended March 31, 2013 and March 31, 2012. A reduction in commission expenses due to product mix changes in the U.S., has been fully offset by the additional expense created by the recently enacted medical device excise tax ($0.6 million).

General and administrative expense. General and administrative expense was $11.1 million for the three months ended March 31, 2013 compared to $8.8 million for the three months ended March 31, 2012, representing an increase of $2.3 million, or 26.1%. The increase was primarily related to increased litigation expense ($1.3 million), increased expenses related to executive management and consulting costs ($1.0 million), and the expenses resulting from the Phygen acquisition ($0.5 million), offset by a reduction in sales and use tax accruals ($0.5 million).

Amortization of acquired intangible assets. Amortization of acquired intangible assets was $0.8 million for the three months ended March 31, 2013 compared to $0.6 million for the three months ended March 31, 2012, representing an increase of $0.2 million, or 38.2%. This expense represents amortization in the period for intangible assets associated with general business assets obtained in the Scient'x and Phygen acquisitions.

Interest expense. Interest expense was $0.7 million for the three months ended March 31, 2013 and $0.7 million for the three months ended March 31, 2012. Interest expense consisted primarily of interest related to loan agreements and lines of credit and the associated amortization expenses related to loan costs.

Other income (expense), net. Other expense was $0.7 million for the three months ended March 31, 2013 compared to $0.3 million for the three months ended March 31, 2012, representing an increase in expense of $0.4 million, or 151.0%. The increase was primarily due to unfavorable foreign currency exchange results realized in 2013 due to having U.S. denominated assets and liabilities on our foreign subsidiaries books as compared to 2012.

Income tax provision (benefit). Income tax was a benefit of $0.1 million for the three months ended March 31, 2013 compared a provision of $0.2 million for the three months ended March 31, 2012. The income tax benefit consists primarily of income tax benefits related to operations in Japan and Brazil, partially offset by state income taxes, the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill and operations in the Company's other foreign jurisdictions.


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Non-GAAP Financial Measures

We utilize certain financial measures that are not calculated based on Generally Accepted Accounting Principles, or GAAP. Certain of these financial measures are considered "non-GAAP" financial measures within the meaning of Item 10 of Regulation S-K promulgated by the SEC. We believe that non-GAAP financial measures reflect an additional way of viewing aspects of our operations that, when viewed with the GAAP results, provide a more complete understanding of our results of operations and the factors and trends affecting our business. These non-GAAP financial measures are also used by our management to evaluate financial results and to plan and forecast future periods. However, non-GAAP financial measures should be considered as a supplement to, and not as a substitute for, or superior to, the corresponding measures calculated in accordance with GAAP. Non-GAAP financial measures used by us may differ from the non-GAAP measures used by other companies, including our competitors.

Adjusted EBITDA represents net income (loss) excluding the effects of interest, taxes, depreciation, amortization, stock-based compensation and other non-recurring income or expense items, such as in-process research and development expense and acquisition related transaction expenses, restructuring expenses and litigation settlement expenses. We believe that the most directly comparable GAAP financial measure to adjusted EBITDA is net income (loss). Adjusted EBITDA has limitations, therefore, it should not be considered either in isolation or as a substitute for analysis of our results as reported under GAAP. Furthermore, adjusted EBITDA should not be considered as an alternative to operating income (loss) or net income (loss) as a measure of operating performance or to net cash provided by operating, investing or financing activities, or as a measure of our ability to meet cash needs.

The following is a reconciliation of adjusted EBITDA to the most comparable GAAP measure, net loss, for the three months ended March 31, 2013 and 2012 (in thousands):

                                                  Three Months Ended March 31,
                                                   2013                  2012
  Net loss                                     $      (2,649 )       $      (1,261 )
  Stock-based compensation                             1,184                   547
  Depreciation                                         3,521                 3,456
  Amortization of intangible assets                    1,514                 1,394
  Amortization of acquired intangible assets           1,224                   953
  Interest expense, net                                  693                   669
  Income tax (benefit) provision                         (52 )                 207
  Other expense, net                                     650                   259

  Adjusted EBITDA                              $       6,085         $       6,224

Liquidity and Capital Resources

At March 31, 2013, our principal sources of liquidity consisted of cash and cash equivalents of $19.3 million and accounts receivable, net of $40.7 million. Based on our operating plan and cash forecast, management believes that on a combined basis, such amounts will be sufficient to fund our projected operating requirements through at least March 31, 2014.

On June 7, 2012, we entered into a credit facility, or the Credit Facility, with MidCap Financial, LLC, or MidCap which permits us to borrow up to $50 million. The Credit Facility is due in June 2015 and consists of a revolving line of credit with a maximum borrowing base of $40 million, with the option to increase the maximum borrowing base to $50 million with the consent of MidCap. The Credit Facility bears an interest rate equal to the London Interbank Market Rate, or LIBOR, plus 6.0%.

The Credit Facility contains certain financial covenants which require us to maintain a certain fixed charge coverage ratio and a senior leverage ratio in order to avoid default under the Credit Facility. We were in compliance with all of the covenants of the Credit Facility as of March 31, 2013. (See "Credit Facility and Other Debt" below).

Based on our current operating plan, we believe that we will be in compliance with our financial covenants under the Credit Facility for the foreseeable future. However, there is no assurance that we will be able to do so. If we are not able to achieve our planned revenue or incur costs in excess of our forecasts, we may be required to substantially reduce discretionary spending, and we could be in default of the Credit Facility. Upon the occurrence of an event of default which is not waived by MidCap, MidCap could elect to declare the amounts outstanding under the Credit Facility immediately due and payable and refuse to extend further credit. If MidCap were to accelerate the repayment of borrowings under the Credit Facility, we may not have sufficient cash on hand to repay the amounts due under the Credit Facility and would have to seek to amend the terms of the Credit Facility or seek alternative financing. There can be no assurances that in the event of a default, a waiver could be obtained from MidCap, that the Credit Facility could be successfully renegotiated or that we could modify our operations to maintain liquidity. If we are forced to seek additional financing, which may include additional debt and/or equity financing or funding through other third party agreements, there can be no assurances that additional financing will be available on favorable terms or available at all. Furthermore, any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants.


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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 surgical instruments, repayments of borrowings and payments due under the Biomet settlement agreement. 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 anticipate that to the extent that we require additional liquidity, it will be funded through borrowings under our revolving credit facility, the incurrence of other indebtedness, additional equity financings or a combination of these potential sources of liquidity.

We will need to invest in working capital and surgical instruments (the costs of which are capitalized) in order to support our revenue projections through 2013. Should we not be able to achieve our revenue forecast and cash consumption starts to exceed forecasted consumption, management will need to adjust our investment in surgical instruments and manage our inventory to the decreased sales volumes. If we do not make these adjustments in a timely manner, there could be an adverse impact on our financial resources. Our revenue projections may be negatively impacted as a result of a decline in sales of our products, including declines due to changes in our customers' ability to obtain third-party coverage and reimbursement for procedures that use our products, increased pricing pressures resulting from intensifying competition, and cost increases and slower product development cycles resulting from a changing regulatory environment.

A substantial portion of our available cash funds is held in business accounts with reputable financial institutions. However, our deposits, at times, may exceed federally insured limits and thus we may face losses in the event of insolvency of any of the financial institutions where our funds are deposited. Additionally, the capital markets have recently been highly volatile and there has been a lack of liquidity for certain financial instruments, especially those with exposure to mortgage-backed securities and auction rate securities. This lack of liquidity has made it difficult for the fair value of these types of instruments to be determined. We did not hold any marketable securities as of March 31, 2013.

Operating Activities

We used net cash of $0.3 million from operating activities for the three months ended March 31, 2013. During this period, net cash used in operating activities primarily consisted of a net loss of $2.6 million and an increase in working capital and other assets of $7.1 million, which were offset by $9.4 million of non-cash costs including amortization, depreciation, deferred income taxes, stock-based compensation, provision for excess and obsolete inventory, and interest expense related to amortization of debt discount and issue costs. The increase in working capital and other assets of $7.1 million consisted of increases in inventory of $3.4 million and increases in accounts receivable of $0.7 million and decreases in accrued expenses and other liabilities of $4.3 million, partially offset by decreases in accounts payable of $0.9 million and decreases in prepaid expenses and other assets of $0.4 million.

Investing Activities

We used net cash of $2.8 million in investing activities for the three months ended March 31, 2013 primarily for the purchase of surgical instruments and a payment under a licensing agreement.

Financing Activities

Financing activities provided net cash of $0.4 million from for the three months ended March 31, 2013. Net borrowings under the Credit Facility totaled $1.2 million in the three months ended March 31, 2013. We made principal payments on notes payable and capital leases totaling $0.8 million in the three months ended March 31, 2013.

Credit Facility and Other Debt

On June 7, 2012, we entered into a Credit Facility with MidCap, which permits us to borrow up to $50 million. The Credit Facility is due in June 2015 and consists of a revolving line of credit with a maximum borrowing base of $40 million, with the option to increase the maximum borrowing base to $50 million with the consent of MidCap. The borrowing base is determined, from time to


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time, based on the value of domestic and foreign eligible accounts receivable and domestic eligible inventory. As collateral for the Credit Facility, we granted MidCap a security interest in substantially all of our assets, including all accounts receivable and all securities evidencing our interests in our subsidiaries.

The Credit Facility includes traditional lending and reporting covenants which among other things requires us to maintain a fixed charge coverage ratio and a senior leverage ratio. The Credit Facility also includes several potential events of default, such as payment default and insolvency conditions, which could cause interest to be charged at a rate which is up to five percentage points above the rate effective immediately before the event of default or result in MidCap's right to declare all outstanding obligation immediately due and payable. In January 2013, we entered into a limited waiver and limited consent agreement with MidCap. The waiver gave us consent on certain provisions under the Credit Facility related to the acquisition of Phygen and maintenance of cash balances in the U.S. In February 2013, we entered into a first amendment to the Credit Facility with MidCap. The first amendment allows us to exclude payments related to the Phygen acquisition and the settlement agreement with Cross Medical Products, LLC from calculation of the fixed charge coverage ratio and the senior leverage ratio. In conjunction with the first amendment, we paid MidCap a fee of $0.1 million. We were in compliance with all of the covenants of the Credit Facility as of March 31, 2013.

We have various capital lease arrangements. The leases bear interest at rates ranging from 4.5% to 9.6%, are generally due in monthly principal and interest installments, are collateralized by the related equipment, and have various maturity dates through 2017. As of March 31, 2013, the balance of these capital leases totaled $1.6 million

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