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ATEC > SEC Filings for ATEC > Form 10-Q on 1-May-2014All Recent SEC Filings

Show all filings for ALPHATEC HOLDINGS, INC.

Form 10-Q for ALPHATEC HOLDINGS, INC.


1-May-2014

Quarterly Report


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

You should read the following in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto that appear elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K filed on March 20, 2014. In addition to historical information the following management's discussion and analysis of our financial condition and results of operations includes forward-looking information that involve risks, uncertainties, and assumptions. Our actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, such as those set forth in our Annual Report on Form 10-K for the year ending December 31, 2013 and any updates to those risk factors filed from time to time in our Quarterly Reports on Form 10-Q.
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. In general, except for those countries where we have a direct sales force (the U.S., Japan, 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 and marketing costs.
General and administrative expense. General and administrative expense consists primarily of salaries and related employee benefits, professional service fees and legal expenses.


Restructuring expenses. Restructuring expenses consists 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.
Total other income (expense). Total other income (expense) includes interest income, interest expense, gains and losses from foreign currency exchanges, gains and losses on warrant liability and other non-operating gains and losses. Income tax provision (benefit). Income tax provision (benefit) consists primarily of state and foreign income taxes and the tax effect of changes in deferred tax liabilities associated with tax goodwill. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of 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 we believe 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, 2014 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, 2013.
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,
                                              2014          2013
Revenues                                   $  49,173     $ 50,443
Cost of revenues                              15,433       17,270
Amortization of acquired intangible assets       446          431
Gross profit                                  33,294       32,742
Operating expenses:
Research and development                       4,181        3,682
Sales and marketing                           18,059       18,495
General and administrative                    14,222       11,130
Amortization of acquired intangible assets       758          793
Restructuring expenses                           776            -
Total operating expenses                      37,996       34,100
Operating loss                                (4,702 )     (1,358 )
Other income (expense):
Interest income                                    3            2
Interest expense                              (1,688 )       (695 )
Other income (expense), net                      383         (650 )
Total other income (expense)                  (1,302 )     (1,343 )
Pretax net loss                               (6,004 )     (2,701 )
Income tax provision (benefit)                   669          (52 )
Net loss                                   $  (6,673 )   $ (2,649 )


Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013
Revenues. Revenues were $49.2 million for the three months ended March 31, 2014 compared to $50.4 million for the three months ended March 31, 2013, representing a decrease of $1.3 million, or 2.5%. The decrease was primarily comprised of $1.0 million related to sales in the U.S. region and $0.3 million related to sales in the International region.
U.S. revenues were $32.1 million for the three months ended March 31, 2014 compared to $33.1 million for the three months ended March 31, 2013, representing a decrease of $1.0 million, or 3.1%. The decrease was due primarily to a decline in sales of Biologics of $0.9 million resulting from the voluntary removal of Puregen from the market in 2013 ($1.0 million).
International revenues were $17.1 million for the three months ended March 31, 2014 compared to $17.4 million for the three months ended March 31, 2013, representing a decrease of $0.3 million, or 1.5%. The decrease was due to a reduction of sales in France as a result of the restructuring ($1.5 million), offset by an increase of sales of Alphatec implants and instruments in Japan ($1.3 million). The decrease in revenue is inclusive of $0.7 million in unfavorable exchange rate effect.
Cost of revenues. Cost of revenues was $15.4 million for the three months ended March 31, 2014 compared to $17.3 million for the three months ended March 31, 2013, representing a decrease of $1.8 million, or 10.6%. The decrease was primarily the result of a reduction in amortization expense related to the Cross Medical settlement, for which expenses concluded in 2013 ($1.1 million). In addition, there was a decrease related to lower product costs as a result of sales volume and variation in product mix ($1.0 million) and a decrease in inventory reserves and adjustments ($0.4 million), offset by an increase in royalty and milestone expenses due to change in product mix ($0.7 million). Amortization of acquired intangible assets. Amortization of acquired intangible assets was $0.4 million for both the three months ended March 31, 2014 and 2013. This expense represents amortization in the period for intangible assets associated with product related assets obtained in acquisitions. Gross profit. Gross profit was $33.3 million for the three months ended March 31, 2014 compared to $32.7 million for the three months ended March 31, 2013, representing an increase of $0.6 million, or 1.7%. The increase was due to a reduction in the cost of revenues resulting from the decrease in amortization expense ($1.1 million), a decrease in inventory reserves and adjustments ($0.5 million), and improved product cost and mix ($0.7 million), offset by a decrease in sales volume ($1.0 million) and an increase in royalty and milestone expenses due to a change in product mix ($0.7 million).
Gross margin. Gross margin was 67.7% for the three months ended March 31, 2014 compared to 64.9% for the three months ended March 31, 2013. The increase of 2.8 percentage points was due to a reduction in amortization expense related to the Cross Medical settlement, for which expenses concluded in 2013 (2.2 percentage points), favorable variation in pricing and product mix (1.4 percentage points) and a decrease in inventory reserves and adjustments (0.6 percentage points), offset by an increase in royalty and milestone expenses due to a change in product mix (1.4 percentage points).
Gross margin for the U.S. region was 71.9% for the three months ended March 31, 2014 compared to 67.8% for the three months ended March 31, 2013. The increase of 4.1 percentage points was due to a reduction in amortization expense related to the Cross Medical settlement, for which expenses concluded in 2013 (3.3 percentage points) and favorable variation in pricing and product mix (3.6 percentage points), offset by an increase in royalty and milestone expenses due to a change in product mix (2.3 percentage points), and an increase in inventory reserves and adjustments (0.5 percentage points).
Gross margin for the International region was 59.8% for the three months ended March 31, 2014 compared to 59.4% for the three months ended March 31, 2013. The increase of 0.4 percentage points was due to a reduction in inventory reserves and adjustments (3.0 percentage points), offset by an unfavorable variation in pricing and product mix (2.6 percentage points).
Research and development expense. Research and development expense was $4.2 million for the three months ended March 31, 2014 compared to $3.7 million for the three months ended March 31, 2013, representing an increase of $0.5 million, or 13.6%. The increase 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 $18.1 million for the three months ended March 31, 2014 compared to $18.5 million for the three months ended March 31, 2013, representing a decrease of $0.4 million, or 2.4%. The decrease was primarily due to a reduction of marketing expenses in the International region resulting from the restructuring of the Scient'x organization.
General and administrative expense. General and administrative expense was $14.2 million for the three months ended March 31, 2014 compared to $11.1 million for the three months ended March 31, 2013, representing an increase of $3.1 million, or 27.8%. The increase was due to an increase in the legal expenses associated with the Orthotec litigation.
Amortization of acquired intangible assets. Amortization of acquired intangible assets was $0.8 million for the three months ended March 31, 2014 compared to $0.8 million for the three months ended March 31, 2013. This expense represents amortization in the period for intangible assets associated with general business assets obtained in acquisitions.


Restructuring expenses. Restructuring expenses was $0.8 million for the three months ended March 31, 2014 compared to $0.0 million for the three months ended March 31, 2013. 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 further reduction in Scient'x's workforce and closing of the manufacturing facilities in France. 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 $10.4 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.
Interest expense. Interest expense was $1.7 million for the three months ended March 31, 2014 and $0.7 million for the three months ended March 31, 2013 representing an increase of $1.0 million, or 142.9%. The increase of $1.0 million is primarily due to interest on higher levels of borrowings under the MidCap facility of $0.4 million and interest expense and amortization of debt discount of $0.3 million related to the Deerfield facility.
Other income (expense), net. Other income (expense), net was income of $0.4 million for the three months ended March 31, 2014 compared to expense of $(0.7) million for the three months ended March 31, 2013. The income for the three months ended March 31, 2014 was primarily due to favorable foreign currency exchange results realized in 2014 due to having U.S. dollar denominated assets and liabilities on our foreign subsidiaries books as compared to 2013 and $0.1 million of income related to the change in fair value of common stock warrant liability.
Income tax provision (benefit). Income tax provision (benefit) was a provision of $0.7 million for the three months ended March 31, 2014 compared to a benefit of $(0.1) million for the three months ended March 31, 2013. The income tax provision in 2014 consists primarily of state and foreign income taxes and the tax effect of changes in deferred tax liabilities associated with tax deductible goodwill. The income tax benefit in 2013 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 our other foreign jurisdictions. 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, other income (expense) and other non-recurring income or expense items, such as litigation expenses and trial costs, in-process research and development expense, acquisition related transaction expenses and restructuring expenses. We believe that the most directly comparable GAAP financial measure to adjusted EBITDA is net income (loss). Adjusted EBITDA has limitations. Therefore, adjusted EBITDA 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, 2014 and 2013 (in thousands):

                                              Three Months Ended March 31,
                                                 2014               2013
Net loss                                   $      (6,673 )     $      (2,649 )
Stock-based compensation                             944               1,184
Depreciation                                       3,250               3,521
Amortization of intangible assets                    397               1,514
Amortization of acquired intangible assets         1,204               1,224
Interest expense, net                              1,685                 693
Income tax provision (benefit)                       669                 (52 )
Other income (expense), net                         (383 )               650
Restructuring and other expenses                     812                   -
Litigation expenses and trial costs                4,779                   -
Adjusted EBITDA                            $       6,684       $       6,085

Liquidity and Capital Resources
At March 31, 2014, our principal sources of liquidity consisted of cash of $23.8 million and accounts receivable, net of $38.8 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, 2015. We expect to fund the operating expenses, including the French Scient'x restructuring expenses, from available cash, cash flow from operating activity and unused availability under the revolving credit and term loan with MidCap Financial, LLC, or MidCap, and a facility agreement, ("the Facility Agreement"), with Deerfield Private Design Fund II, L.P., Deerfield Private Design International II, L.P., Deerfield Special Situations Fund, L.P., and Deerfield Special Situations International Master Fund, L.P., (collectively, "Deerfield") entered into during the three months ended March 31, 2014. We will use the restricted cash of $17.8 million and proceeds from the Facility Agreement to pay amounts due under the Orthotec settlement discussed below. On June 7, 2012, we entered into a credit facility, or the Credit Facility, with MidCap, which was amended and restated on August 30, 2013 to, among other things, increase the borrowing limit from $50 million to $73 million. The Credit Facility is due in August 2016 and consists of a revolving line of credit with a maximum borrowing base of $40 million and a $28 million term loan with an additional $5 million delayed draw for 12 months. The $5 million delayed draw was borrowed on April 1, 2014. The revolving line bears an interest rate equal to the London Interbank Market Rate, or LIBOR, plus 6.0% and the term loan bears an interest rate of LIBOR plus 8.0%, subject to a 9.5% floor.
The Credit Facility contains certain financial covenants which require us to maintain a certain fixed charge coverage ratio, a senior leverage ratio and a total 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, 2014. See "Credit Facility and Other Debt" below.
On March 15, 2014, we, Orthotec and certain other parties, including certain directors and affiliates entered into a binding term sheet to settle the pending litigation in the Orthotec, LLC vs. Surgical S.A.S. legal matter and all other litigation matters between Orthotec, LLC and us and our directors and affiliates. Pursuant to the binding term sheet, we have agreed to pay Orthotec $49 million in cash payments. In accordance with the binding term sheet, we made payments totaling $1.75 million in March 2014 and we made an additional $15.75 million payment on April 10, 2014. We will pay the remaining $31.5 million to Orthotec in 28 quarterly installments of $1.1 million beginning in the fourth quarter of 2014. HealthpointCapital has agreed to contribute $5 million to the $49 million settlement amount. In addition, a 7% simple interest rate will accrue on the unpaid portion of the remaining $31.5 million that we owe, which we will pay in $1.1 million quarterly payments after the $49 million settlement amount is paid. We anticipate funding a portion of the 2014 payment obligations with proceeds from the Facility Agreement described in the next paragraph. On March 17, 2014, we entered into the Facility Agreement, pursuant to which Deerfield agreed to loan us up to $50 million, subject to the terms and conditions set forth in the Facility Agreement. Under the terms of the Facility Agreement, we have the option, but are not required, upon certain conditions to draw the entire amount available under the Facility Agreement, at any time until January 30, 2015 provided that the initial draw be used for a portion of the payments made in connection with the Orthotec settlement described above, or the Litigation Satisfaction. Following such initial draw down, we may draw down additional amounts under the Facility Agreement up to an aggregate of $15.0 million for working capital or general corporate


purposes. In addition, in the event the Litigation Satisfaction has not occurred prior to December 15, 2014, we may request no later than January 30, 2015 a draw of the entire amount available under the Facility Agreement; provided that such amount will remain in a special deposit account until the Litigation Satisfaction occurs. We agreed to pay Deerfield, upon each disbursement of funds under the Facility Agreement, a transaction fee equal to 2.5% of the principal amount of the funds disbursed in addition to the issuance of additional warrants to purchase up to 10,000,000 shares of the Company's common stock to Deerfield. On March 20, 2014, we drew $20 million under the Facility Agreement and received net proceeds of $19.5 million to fund the 2014 Orthotec settlement payment obligations.
Based on our current operating plan, we believe that we will be in compliance with our financial covenants under the Credit Facility and the Facility Agreement 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 if we 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 and the Facility Agreement. Upon the occurrence of an event of default which is not waived by MidCap or Deerfield, they could declare the amounts outstanding under the Credit Facility and the Facility Agreement immediately due and payable and refuse to extend further credit. If MidCap or Deerfield were to accelerate the repayment of borrowings under the Credit Facility and the Facility Agreement, we may not have sufficient cash on hand to repay the amounts due under the Credit Facility and the Facility Agreement and would have to seek to amend the terms of the Credit Facility and the Facility Agreement or seek alternative financing. There can be no assurance that in the event of a default, a waiver could be obtained from MidCap or Deerfield, that the Credit Facility and the Facility Agreement 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 assurance 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.
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 under the Credit Facility and payments due under the Cross Medical and Orthotec settlement agreements. 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 . . .

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