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MAKO > SEC Filings for MAKO > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for MAKO SURGICAL CORP.


6-Nov-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

In this report, "MAKO Surgical," "MAKO," the "Company," "we," "us" and "our" refer to MAKO Surgical Corp.

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes appearing elsewhere in this report. This report contains forward-looking statements regarding, among other things, statements related to expectations, goals, plans, objectives and future events. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Securities Exchange Act of 1934 and the Private Securities Reform Act of 1995. In some cases, you can identify forward-looking statements by the following words: "may," "will," "could," "would," "should," "expect," "intend," "plan," "anticipate," "believe," "estimate," "predict," "project," "potential," "continue," "ongoing," "outlook," "guidance" or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Examples of such statements include, but are not limited to, statements about our ability to complete the Merger with Stryker Corporation; the nature, timing and number of planned new product introductions; market acceptance of MAKOplasty, including our RIOฎ Robotic Arm Interactive Orthopedic system, or RIO, joint specific applications for the knee and hip, and our RESTORIS family of implant systems; the effect of anticipated changes in the size, health and activities of population on the demand for our products; assumptions and estimates regarding the size and growth of certain market segments; our ability and intent to expand into international markets; the timing and anticipated outcome of clinical studies; assumptions concerning anticipated product developments and emerging technologies; the future availability from third parties, including single source suppliers, of development services and implants for and components of our RIO; the viability of maintaining our licensed intellectual property or our ability to obtain additional licenses necessary to our growth; the anticipated adequacy of our capital resources to meet the needs of our business; our continued investment in new products and technologies; the ultimate marketability of newly launched products and products currently being developed; the ability to implement new technologies successfully; our ability to sustain, and our goals for, sales and earnings growth, including projections regarding RIO system installations and post-installation system utilization; our success in achieving timely approval or clearance of products with domestic and foreign regulatory entities; our compliance with domestic and foreign regulatory requirements, including Medical Device Reporting requirements and other required reporting to the United States Food and Drug Administration; the stability of certain domestic and foreign economic markets; the impact of anticipated changes in the U.S. healthcare industry and the medical device industry and our ability to react to and capitalize on those changes; future declarations of cash dividends; and the impact of any managerial changes. These statements are based on the current estimates and assumptions of our management as of the date of this report and are subject to risks, uncertainties, changes in circumstances, assumptions and other factors that may cause actual results to differ materially from those indicated by forward-looking statements, many of which are beyond our ability to control or predict. Such factors, among others, may have a material adverse effect on our business, financial condition and results of operations and may include the following:

• the occurrence of any event, change or other circumstance that could give rise to the termination of the Merger Agreement with Stryker Corporation;

• the failure to complete or a delay in the completion of the proposed Merger with Stryker for any reason including, without limitation, the failure to obtain the required vote of our stockholders to adopt the Merger Agreement, the failure to obtain the required regulatory approval, or the failure to satisfy any of the other closing conditions of the Merger;

• risks related to disruption of management's attention from our ongoing business operations due to the pendency of the Merger or the integration of the acquired business of Pipeline Biomedical Holdings, Inc.;

• the effect of the announcement of the Merger or the integration of the acquired business of Pipeline on our ability to maintain relationships with our customers and suppliers and maintain our operating results and business generally;

• the potentially significant impact of a continued economic downturn or delayed economic recovery on the ability of our customers to secure adequate funding, including access to credit, for the purchase of our products or cause our customers to delay a purchasing decision;


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• changes in general economic conditions and credit conditions;

• changes in the availability of capital and financing sources for our company and our customers;

• unanticipated changes in the timing and duration of the sales cycle for our products or the vetting process undertaken by prospective customers;

• changes in competitive conditions and prices in our markets;

• changes in the relationship between supply of and demand for our products;

• fluctuations in costs and availability of raw materials, finished goods (including from sole-sourced suppliers), and labor;

• changes in other significant operating expenses;

• slowdowns, delays, or inefficiencies in our product research and development efforts;

• unanticipated issues relating to intended product launches;

• decreases in sales of our principal product lines;

• decreases in utilization of our principal product lines or in procedure volume or system utilizations;

• increases in expenditures related to increased or changing governmental regulation or taxation of our business, both nationally and internationally;

• unanticipated issues in complying with domestic or foreign regulatory requirements related to MAKO's current or future products, including initiating and communicating product actions or product recalls and meeting Medical Device Reporting requirements and other requirements of the United States Food and Drug Administration, or securing regulatory clearance or approvals for new products or upgrades or changes to our current products;

• developments adversely affecting our current and potential sales activities outside the United States;

• increases in cost containment efforts by group purchasing organizations;

• the impact of the United States healthcare reform legislation enacted in March 2010 on hospital spending, reimbursement, and the taxing of medical device companies;

• unanticipated changes in reimbursement to our customers for our products;

• any unanticipated impact arising out of the legal proceedings that have been or may be instituted against us and others relating to the Merger, as well as any other litigation, inquiry, or investigation brought against us;

• any negative impact from the generation or interpretation of clinical study results related to MAKOplasty;

• loss of key management and other personnel or inability to attract and/or retain such management and other personnel including as a result of the planned Merger;

• increases in costs of retaining a direct sales force and building a distributor network;

• unanticipated issues related to, or unanticipated changes in or difficulties associated with, the recruitment of agents and distributors of our products; and

• unanticipated intellectual property expenditures required to develop, market, protect, and defend our products or market position.

These and other risks are described in greater detail under Item 1A, Risk Factors, of this Quarterly Report on Form 10-Q, and Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2012. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We do not undertake any obligation to release any revisions to these forward-looking statements publicly to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.


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We have received or applied for trademark registration of and/or claim trademark rights, including in the following marks: "MAKOplastyฎ," "RIOฎ" and "RESTORISฎ," as well as in the MAKO Surgical Corp. "MAKO" logo, whether standing alone or in connection with the words "MAKO Surgical Corp."

Overview

We are an emerging medical device company that markets our RIO Robotic-Arm Interactive Orthopedic system, joint specific applications for the knee and hip, and proprietary RESTORIS implants for orthopedic procedures. We offer MAKOplasty, an innovative, restorative surgical solution that enables orthopedic surgeons to consistently, reproducibly and precisely treat patient specific osteoarthritic disease. Our common stock is listed on The NASDAQ Global Select Market under the ticker symbol "MAKO."

We have incurred net losses in each year since our inception and, as of September 30, 2013, we had an accumulated deficit of $272.2 million. We expect to continue to incur significant operating losses as we increase our sales and marketing activities and otherwise continue to invest capital in the development and expansion of our products and our business generally. We expect that our selling, general and administrative expenses will continue to increase to support the sales and marketing efforts associated with the growing commercialization of MAKOplasty and to support our continued growth in operations. We also expect our research and development expenses to increase as we continue to expand our research and development activities, including the support of existing products and the research and development of potential future products.

Recent business events and key milestones in the development of our business include the following:

• During the nine month period ended September 30, 2013, we sold nineteen RIO systems, comprised of fifteen domestic commercial sales, three international commercial sales and one international demonstration sale, and six MAKOplasty total hip arthroplasty applications, or THA applications, to existing RIO customers. We deferred recognition of one international commercial sale and one international demonstration sale as all revenue recognition criteria consistent with the Company's revenue recognition policy had not been satisfied as of September 30, 2013. We also recognized the revenue associated with two previously deferred international commercial RIO system sales during the nine months ended September 30, 2013, as all revenue recognition criteria consistent with the Company's revenue recognition policy had been satisfied.

• As of September 30, 2013, our worldwide commercial installed base was 174 systems and our domestic commercial installed base was 166 systems. Of the installed base of 174 systems, 115 systems, or 66% of our worldwide commercial installed base, have the MAKOplasty THA application.

• A total of 9,521 MAKOplasty procedures were performed worldwide during the nine month period ended September 30, 2013, representing a 30% increase over the same period in 2012.

• As further discussed below, on September 25, 2013, we entered into an Agreement and Plan of Merger with Stryker Corporation.

• On October 8, 2013, pursuant to an Asset Purchase Agreement, we completed the acquisition of substantially all of Pipeline Biomedical Holdings, Inc.'s business dedicated to the design, development, manufacture and commercialization of orthopedic devices and related instruments for use with robotic devices and manual medical procedures.


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We believe that the keys to continuing to grow our business are expanding the acceptance and application of MAKOplasty for partial knee resurfacing procedures, gaining market acceptance for our MAKOplasty THA application and associated implant systems and introducing other potential future applications. To successfully commercialize our products and continue to grow our business, we must gain broad market acceptance for MAKOplasty procedures.

Merger Agreement with Stryker Corporation

On September 25, 2013, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Stryker Corporation, a Michigan corporation, or Stryker, and Lauderdale Merger Corporation, a Delaware corporation and wholly-owned subsidiary of Stryker, or Merger Sub.

The Merger Agreement provides, among other things and subject to the terms and conditions set forth therein, that Merger Sub will be merged with and into the Company, or the Merger, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Stryker, and that, at the effective time of the Merger, or the Effective Time, each share of our common stock, par value $0.001 per share, outstanding immediately prior to the Effective Time (other than dissenting shares and shares owned by the Company, Stryker or Merger Sub or any of their subsidiaries) will be automatically converted into the right to receive $30.00 in cash, without interest, or the Merger Consideration.

Pursuant to the Merger Agreement, as of the Effective Time, (1) each option to purchase a share of our common stock that is outstanding immediately prior to the Effective Time will become fully vested and be converted into the right to receive a cash payment equal to the Merger Consideration, net of the exercise price, (2) each award of restricted shares of our common stock that is outstanding immediately prior to the Effective Time will become fully vested and be converted into the right to receive a cash payment equal to the product of the Merger Consideration and the number of shares subject to the award, and (3) each unexercised Company warrant that is outstanding immediately prior to the Effective Time will, in accordance with the terms of the applicable warrant, no longer be exercisable for any capital stock of the surviving corporation, but will only be exercisable or canceled, as applicable, in accordance with the terms of the applicable warrant in exchange for the Merger Consideration.

Our Board of Directors, or the Board, has unanimously approved the Merger Agreement, the Merger and the other transactions contemplated thereby. The closing of the Merger is subject to the adoption of the Merger Agreement by the affirmative vote of the holders of a majority of the outstanding shares of our common stock entitled to vote, or the Company Stockholder Approval. The closing of the Merger is also subject to various customary conditions, including the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; the absence of any newly enacted law, injunction or order prohibiting the Merger; the accuracy of the representations and warranties contained in the Merger Agreement (generally subject to a material adverse effect qualification); compliance with the covenants and agreements in the Merger Agreement in all material respects; and, until August 31, 2014, the absence of certain pending actions by governmental entities against the parties to the Merger Agreement or their subsidiaries. The closing of the Merger is not subject to a financing condition.

We have made customary representations, warranties and covenants in the Merger Agreement, including, among others, covenants (1) to conduct its business in the ordinary course during the period between the execution of the Merger Agreement and the closing of the Merger, (2) not to engage in specified types of transactions during this period unless agreed to in writing by Stryker, (3) to convene and hold a meeting of our stockholders for the purpose of obtaining the Company Stockholder Approval and (4) subject to certain exceptions, not to withdraw, modify or qualify in a manner adverse to Stryker or Merger Sub the recommendation of the Board that the our stockholders approve the adoption of the Merger Agreement.

The Merger Agreement contains certain termination rights, including our right to terminate the Merger Agreement to accept an unsolicited superior proposal from a third party. The Merger Agreement provides that, upon termination of the Merger Agreement by us in order to accept a superior proposal, a termination fee of $61.0 million will be payable by us to Stryker. The termination fee is also payable under certain other limited circumstances, including if Stryker terminates the Merger Agreement due to the Board's change of recommendation in favor of the Merger or our failure to include the Board's recommendation in favor of the Merger in the proxy statement. In addition, subject to certain exceptions and limitations, either party may terminate the Merger Agreement if the Merger is not consummated by September 30, 2014.


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We retained J.P. Morgan as our financial advisor in connection with the proposed Merger and to deliver a fairness opinion in connection with the proposed Merger. We have agreed to pay J.P. Morgan an aggregate fee of approximately $19.0 million, of which approximately $16.0 million will be payable upon completion of the Merger, and of which $3.0 million was earned upon delivery of J.P. Morgan's opinion and was not contingent on the consummation of any transaction. The $3.0 million was recorded to expense in merger transaction expenses in the condensed statement of operations for the three months ended September 30, 2013. In addition, we have agreed to reimburse J.P Morgan for its reasonable expenses incurred in connection with its services, including the fees and disbursements of counsel, and will indemnify J.P. Morgan against certain liabilities, including liabilities arising under the Federal securities laws.

Factors That May Influence Future Results of Operations

The following is a description of factors that may influence our future results of operations, including significant trends and challenges that we believe are important to an understanding of our business and results of operations.

Revenue

Revenue is generated from: (1) sales of RIO systems and applications, (2) sales of implants and disposable products utilized in MAKOplasty procedures; and
(3) sales of maintenance services. Future revenue from sales of our products is difficult to predict and we expect that it will only modestly reduce our continuing losses resulting from selling, general and administrative expenses, research and development expenses and other activities for approximately the next two years. Our future revenue may also be adversely affected by the current general economic conditions and the resulting tightening of the credit markets, which may cause purchasing decisions to be delayed or cause our customers to experience difficulties in securing adequate funding to buy our products.

The generation of recurring revenue through sales of our implants, disposable products and maintenance contracts is an important part of the MAKOplasty business model. We anticipate that recurring revenue will constitute an increasing percentage of our total revenue as we leverage each new installation of our RIO system to generate recurring sales of implants and disposable products and as we expand our RIO applications and implant product offerings, including our MAKOplasty THA application.

Cost of Revenue

Cost of revenue primarily consists of the direct costs associated with the manufacture of RIO systems, implants and disposable products for which revenue has been recognized in accordance with our revenue recognition policy. Costs associated with providing maintenance services are expensed as incurred. Cost of revenue also includes the allocation of manufacturing overhead costs, freight, royalties related to the sale of products covered by licensing arrangements and valuation adjustments for obsolete, impaired or excess inventory.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses consist primarily of expenses relating to compensation, including the direct salary and benefit cost for sales, marketing, training, clinical research, operations, regulatory, quality, finance, legal, executive, and administrative personnel, including stock-based compensation. Other significant expenses include costs associated with sales and marketing activities, marketing and advertising materials, training, insurance, professional fees for legal and accounting services, consulting fees, travel expenses, facility and related operating costs and recruiting and other human resources expenses. Our selling, general and administrative expenses also include the expense relating to the new medical device tax, which became effective January 1, 2013. Our selling, general and administrative expenses are expected to continue to increase due to the planned increase in the number of activities necessary to support the sales and marketing efforts associated with the growing commercialization of MAKOplasty. In addition, we expect to incur additional costs associated with securing, protecting and defending our intellectual property rights as necessary and advisable to support our current and future product offerings.


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We reclassified depreciation expense for certain property and equipment from selling, general and administrative expense to depreciation and amortization expense in the prior period's statement of operations to conform to the current period's presentation as discussed in Note 1 to the Financial Statements. This change in presentation only affects the components of operating costs and expenses and does not affect total operating costs and expenses, revenue, cost of revenue, net loss or cash flows.

Research and Development Expenses

Costs related to research, design and development of products are charged to research and development expense as incurred. These costs include direct salary and benefit costs for research and development employees including stock-based compensation, cost for materials used in research and development activities and costs for outside services. We expect our research and development expenses to increase as we continue to expand our research and development activities, including the support of existing products and the research and development of potential future products.

Critical Accounting Policies

There have been no significant changes in our critical accounting policies during the nine months ended September 30, 2013 as compared to the critical accounting policies described in our Form 10-K for the year ended December 31, 2012.


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Results of Operations for the Three and Nine Months Ended September 30, 2013 and 2012

(dollars in thousands)            Three Months Ended September 30,                  Nine Months Ended September 30,
                                                                  % of                                             % of
                                2013        2012      Change     Change         2013        2012       Change     Change
Revenue:
Procedures                   $   16,224   $ 12,042   $   4,182        35 %    $  47,438   $  36,622   $  10,816        30 %
Systems                           2,695     14,413     (11,718 )     (81 %)      17,425      28,467     (11,042 )     (39 %)
Service                           3,843      2,722       1,121        41 %       10,933       7,402       3,531        48 %
Total revenue                    22,762     29,177      (6,415 )     (22 %)      75,796      72,491       3,305         5 %
Cost of revenue:
Procedures                        4,139      6,226      (2,087 )     (34 %)      15,755      12,001       3,754        31 %
Systems                           1,773      5,453      (3,680 )     (67 %)       7,353      10,697      (3,344 )     (31 %)
Service                             522        295         227        77 %        1,306       1,127         179        16 %
Total cost of revenue             6,434     11,974      (5,540 )     (46 %)      24,414      23,825         589         2 %
Gross profit                     16,328     17,203        (875 )      (5 %)      51,382      48,666       2,716         6 %
Operating costs and
expenses:
Selling, general and
administrative (exclusive
of depreciation and
amortization)                    22,556     19,794       2,762        14 %       64,535      57,953       6,582        11 %
Research and development
(exclusive of depreciation
and amortization)                 6,235      4,973       1,262        25 %       16,881      15,071       1,810        12 %
Merger transaction
expenses                          6,611          -       6,611       100 %        6,611           -       6,611       100 %
Depreciation and
amortization                      2,174      1,787         387        22 %        6,323       5,244       1,079        21 %
Total operating costs and
expenses                         37,576     26,554      11,022        42 %       94,350      78,268      16,082        21 %
Loss from operations            (21,248 )   (9,351 )   (11,897 )     127 %      (42,968 )   (29,602 )   (13,366 )      45 %
Other income (expense),
net                                  (8 )    2,842      (2,850 )    (100 %)      (7,621 )     2,867     (10,488 )    (366 %)
Loss before income taxes        (21,256 )   (6,509 )   (14,747 )     227 %      (50,589 )   (26,735 )   (23,854 )      89 %
Income tax expense                    -         45         (45 )    (100 %)          15          84         (69 )     (82 %)
Net loss                     $  (21,256 ) $ (6,554 ) $ (14,702 )     224 %    $ (50,604 ) $ (26,819 ) $ (23,785 )      89 %

Revenue

Revenue was $22.8 million for the three months ended September 30, 2013, compared to $29.2 million for the three months ended September 30, 2012. The decrease in revenue of $6.4 million, or 22%, was primarily due to an $11.7 million, or 81%, decrease in system revenue, which was partially offset by a $4.2 million, or 35%, increase in procedure revenue and a $1.1 million, or 41%, increase in service revenue.

The $11.7 million decrease in system revenue was attributable to the recognition of $2.7 million of revenue from two commercial unit sales of our RIO system, both of which included MAKOplasty THA applications, two MAKOplasty THA application sales to existing customers, and recognition of one previously deferred international commercial RIO system sale during the three months ended September 30, 2013, as compared to the recognition of $14.4 million of revenue from fifteen commercial unit sales of our RIO system, eleven of which included MAKOplasty THA applications, and three MAKOplasty THA application sales to existing customers during the three months ended September 30, 2012. System revenue for the three months ended September 30, 2013 was reduced by $246,000 for the deferral of system revenue primarily related to our service obligation . . .

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