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ATEC > SEC Filings for ATEC > Form 10-K on 20-Mar-2014All Recent SEC Filings

Show all filings for ALPHATEC HOLDINGS, INC.

Form 10-K for ALPHATEC HOLDINGS, INC.


20-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and the notes to those statements appearing elsewhere in this Annual Report on Form 10-K.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 "physician-inspired culture" enables us to respond to changing surgeon needs 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 surgeons' and patients' critical needs. 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. Today we have existing subsidiaries and/or affiliates in Japan, Germany, Brazil, Hong Kong, Italy and the U.K. through which we sell our products and independent distributors in over 50 countries throughout the world.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. 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, 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. Sales and marketing expense consists primarily of salaries and related employee benefits, sales commissions and support costs, professional service fees, travel, medical education, trade show and marketing costs.


General and administrative. General and administrative expense consists primarily of salaries and related employee benefits, professional service fees, insurance and legal expenses.
Transaction related expenses. Transaction related expenses consist of legal, accounting and financial advisory fees associated with acquisitions. Restructuring expenses. Restructuring expenses consist of severance, social plan benefits and related taxes, facility closing costs, manufacturing transfer costs and contract termination incurred in connection with the reorganization of the Scient'x operations in France.
Litigation settlement expenses. Litigation settlement expenses consist of significant settlements of lawsuits.
Total other income (expense). Total other income (expense) includes interest income, interest expense, gains and losses from foreign currency exchanges and other non-operating gains and losses.
Income tax provision (benefit). Income tax provision (benefit) consists primarily of income tax provision related to state income taxes, foreign operations and uncertain tax positions in foreign jurisdictions, the income tax benefits are primarily due to 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. Our historical results are not necessarily indicative of the operating results that may be expected in the future.

                                                     Year Ended December 31,
                                                2013          2012          2011
                                                         (in thousands)
Revenues                                     $ 204,724     $ 196,278     $ 197,711
Cost of revenues                                78,669        70,761        79,168
Amortization of acquired intangible assets       1,733         1,749         1,613
Gross profit                                   124,322       123,768       116,930
Operating expenses:
Research and development                        14,190        14,886        16,888
In-process research and development                  -           341             -
Sales and marketing                             76,960        75,177        75,189
General and administrative                      47,949        39,939        36,367
Amortization of acquired intangible assets       3,009         2,180         2,152
Transaction related expenses                         -         1,082             -
Restructuring expenses                           9,665             -         1,050
Litigation settlement expenses                  45,982             -         9,800
Total operating expenses                       197,755       133,605       141,446
Operating loss                                 (73,433 )      (9,837 )     (24,516 )
Other income (expense):
Interest income                                      6           118           148
Interest expense                                (3,959 )      (6,105 )      (3,027 )
Other income (expense), net                     (1,662 )        (794 )         707
Total other income (expense)                    (5,615 )      (6,781 )      (2,172 )
Pretax net loss                                (79,048 )     (16,618 )     (26,688 )
Income tax provision (benefit)                   3,179        (1,159 )      (4,507 )
Net loss                                     $ (82,227 )   $ (15,459 )   $ (22,181 )


Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012 Revenues. Revenues were $204.7 million for the year ended December 31, 2013 compared to $196.3 million for the year ended December 31, 2012, representing an increase of $8.4 million, or 4.3%. The increase was comprised of $4.4 million related to sales in the United States and $4.0 million related to international sales.
U.S. revenues were $135.0 million for the year ended December 31, 2013 compared to $130.5 million for the year ended December 31, 2012, representing an increase of $4.5 million, or 3.4%. The increase was due to growth in the sales of implants and instruments ($8.2 million) and Biologics ($2.1 million), offset by a decline in the sales of Puregen due to the voluntary removal from the market ($5.8 million).
International revenues were $69.8 million for the year ended December 31, 2013 compared to $65.8 million for the year ended December 31, 2012, representing an increase of $4.0 million, or 6.0%. The increase was due to sales of Alphatec implants and instruments ($6.5 million), offset by a reduction in the sales of Scient'x products ($2.5 million). The increase in revenue is inclusive of $5.9 million in unfavorable exchange rate effect.
Cost of revenues. Cost of revenues was $78.7 million for the year ended December 31, 2013 compared to $70.8 million for the year ended December 31, 2012, representing an increase of $7.9 million, or 11.2%. The increase was primarily due to one-time charges for increased inventory and instrument reserves related to the restructuring of the Scient'x organization ($5.5 million), the obsolescence of the Puregen inventory ($3.5 million) and the obsolescence of certain inventory related to an interbody fusion MIS product ($1.0 million). In addition to these charges, there is an increase related to higher product costs as a result of sales volume and variation in product mix ($2.1 million), offset by an adjustment to milestone accruals ($0.7 million), a reduction in inventory reserves ($2.9 million) and a reduction in inventory adjustments and other costs of sales ($0.4 million).
Amortization of acquired intangible assets. Amortization of acquired intangible assets was $1.7 million for the years ended December 31, 2013 and December 31, 2012. This expense represents amortization in the period for intangible assets associated with product related assets obtained in acquisitions.
Gross profit. Gross profit was $124.3 million for the year ended December 31, 2013 compared to $123.8 million for the year ended December 31, 2012, representing an increase of $0.6 million, or 0.4%. The increase was due to an increase in sales volume ($6.8 million), a reduction in inventory reserves ($2.9 million), a reversal of milestone accruals ($0.7 million) and a decrease in other cost of revenues ($0.6 million), offset by an increase in the cost of revenues resulting from the restructuring ($5.5 million), product obsolescence ($4.5 million) and an unfavorable variation in product mix ($0.4 million). Gross margin. Gross margin was 60.7% for the year ended December 31, 2013 compared to 63.1% for the year ended December 31, 2012. The decrease of 2.4 percentage points was due to an increase in the cost of revenues resulting from the restructuring (2.6 percentage points), product obsolescence (2.2 percentage points) and an unfavorable variation in pricing and product mix (0.2 percentage points), offset by a reduction in inventory reserves (1.6 percentage points), an adjustment to milestone accruals (0.3 percentage points) and a reduction in other cost of revenues (0.7 percentage points).
Gross margin in the U.S. was 67.7% for the year ended December 31, 2013 compared to 68.5% for the year ended December 31, 2012. The decrease of 0.8 percentage points was due to an increase in the cost of revenues resulting from product obsolescence (3.2 percentage points), offset by a favorable variation in pricing and product mix (0.3 percentage points), a reduction in inventory adjustments (1.1 percentage points) and reduction in other cost of revenues (1.0 percentage points).
Gross margin for the International region was 47.3% for the year ended December 31, 2013 compared to 52.3% for the year ended December 31, 2012. The decrease of 5.0 percentage points was due to an increase in the cost of revenues resulting from the restructuring (7.9 percentage points) and an unfavorable variation in pricing and product mix (0.8 percentage points), offset by a reduction in inventory reserves (3.8 percentage points).
Research and development. Research and development expense was $14.2 million for the year ended December 31, 2013 compared to $14.9 million for the year ended December 31, 2012 representing a decrease of $0.7 million, or 4.7%. The decrease was primarily related to the variations in the timing of the cycle for development and testing ($1.4 million), offset by increased surgeon consulting expenses ($0.7 million).
In-process research and development. IPR&D expense was $0.0 million for the year ended December 31, 2013 compared to $0.3 million for the year ended December 31, 2012. During the fourth quarter of 2012, the Company decided that it would not pursue development of IPR&D assets that had an indefinite life. The Company expensed $0.3 million for IPR&D related to the write-off of a portion of the IPR&D assets acquired in the Scient'x acquisition.
Sales and marketing. Sales and marketing expense was $77.0 million for the year ended December 31, 2013 compared to $75.2 million for the year ended December 31, 2012 representing an increase of $1.8 million, or 2.4%. The increase was primarily due to the additional expense created by the recently enacted medical device excise tax ($1.5 million).


General and administrative. General and administrative expense was $47.9 million for the year ended December 31, 2013 compared to $39.9 million for the year ended December 31, 2012, representing an increase of $8.0 million, or 20.1%. The increase was primarily related to legal fees associated with litigation and product liability claims ($5.4 million), compensation expense ($2.1 million), professional fees ($1.3 million) and expenses resulting from the Phygen acquisition ($0.4 million), offset by a decrease in International expenses related to currency translation ($0.8 million) and general cost reduction ($0.4 million).
Amortization of acquired intangible assets. Amortization of acquired intangible assets was $3.0 million for the year ended December 31, 2013 compared to $2.2 million for the year ended December 31, 2012, representing an increase of $0.8 million, or 38.0%. This expense represents amortization in the period for intangible assets associated with general business assets obtained in acquisitions.
Transaction related expenses. Transaction related expenses were $0.0 million for the year ended December 31, 2013 compared to $1.1 million for the year ended December 31, 2012. The transaction related expenses were due to legal and professional fees in connection with the Company's asset acquisition of Phygen, LLC in 2012.
Restructuring expenses. Restructuring expenses were $9.7 million for the year ended December 31, 2013 compared to $0.0 million for the year ended December 31, 2012. On September 16, 2013, we announced that Scient'x had begun a process to significantly restructure its business operations in France in an effort to improve operating efficiencies and rationalize its cost structure. The restructuring includes an expected reduction in Scient'x's workforce and closing of the manufacturing facilities in France. We recorded restructuring costs of $9.7 million for the year ended December 31, 2013 and there was no corresponding expense for the year ended December 31, 2012. We estimate that we will record total costs, including employee severance, social plan benefits and related taxes, facility closing costs, manufacturing transfer costs and contract termination costs of approximately $12 million associated with this restructuring. We expect to complete all the activities associated with the restructuring activities by the end of the second quarter of 2014, a substantial portion of which will be paid by then.
Litigation settlement expenses. Litigation settlement expenses were $46.0 million for the year ended December 31, 2013. The 2013 amount relates to an accrual booked for litigation settlement in connection with the Orthotec LLC, litigation matter described in Part 1 Item 3 Legal Proceedings. Interest income. Interest income was $0.0 million for the years ended December 31, 2013 compared to $0.1 million for the year ended December 31, 2012. Interest income is earned on cash balances held in accounts invested in money market funds.
Interest expense. Interest expense was $4.0 million for the year ended December 31, 2013 compared to $6.1 million for the year ended December 31, 2012, representing a decrease of $2.1 million, or 35.2%. Interest expense for the year ended December 31, 2013 consisted primarily of interest related to loan agreements and lines of credit and the associated amortization expenses related to debt issuance costs. Interest expense for the year ended December 31, 2012 included a 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, which consisted 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 $(1.7) million for the year ended December 31, 2013 compared to an expense of $(0.8) million for the year ended December 31, 2012, representing an increase in expense of $(0.9) million. The increase in expense 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 provision (benefit) was a provision of $3.2 million for the year ended December 31, 2013 compared to a benefit of $(1.2) million for the year ended December 31, 2012, representing an increase of $4.3 million, or 374.3%. The income tax provision in 2013 consists primarily of income tax provisions related to state income taxes, the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill and operations in foreign jurisdictions where we operate. The income tax benefit in 2012 consists primarily of tax benefits related to operations in France and a settlement with the French tax authorities partially offset by a valuation allowance on the French deferred tax assets, income tax expense for various other foreign jurisdictions, state income taxes and the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill.


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 region 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 instruments and implants ($9.4 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 $1.7 million for the years ended December 31, 2012 compared to $1.6 million for the year ended December 31, 2011, representing an increase of $0.1 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 a 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 due to 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. 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 due to 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. 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. IPR&D expense was $0.3 million for the year ended December 31, 2012 compared to $0.0 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. Sales and marketing expense was $75.2 million for the years ended December 31, 2012 and December 31, 2011. In 2012, expenses increased as a result of 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. 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 expenses. Transaction related expenses were $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 expenses. Restructuring expenses was $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 expenses. Litigation settlement expenses were $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 . . .

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